CALCULATING IMPLICIT COSTS

Implicit skills are skills where all the steps cannot be specified and more than one answer is acceptable

An implicit cost is any cost that has already occurred but not necessarily shown or reported as a separate expense It represents an opportunity cost that arises when a company uses internal resources toward a project without any explicit compensation for the utilization of resources

1. First you have to calculate the costs You can take what you know about explicit costs and total them:
2. Subtracting the explicit costs from the revenue gives you the accounting profit
3. You need to subtract both the explicit and implicit costs to determine the true economic profit

Wages that a firm pays its employees or rent that a firm pays for its office are explicit costs Implicit costs are more subtle, but just as important They represent the opportunity cost of using resources that the firm already owns

Depreciation is recognized expense Although it has the feature of been incurred like implicit cost, however, depreciation represents the ongoing wear and tear of asset that has to be distributed over the number the years In fact, depreciation is recognized as explicit cost and not implicit cost

Although the depreciation of an asset is not an activity that can be tangibly traced, depreciation expense is an explicit cost because it relates to the cost of the underlying asset owned by the company In contrast, implicit or implied costs are not clearly defined, identified, or reported as expenses

Implicit cost is the cost of self supplied factors of production Hence Interest that could have been earned on retained earnings used by the firm to finance expansion is implicit cost

A business owner could be earning a profit even while not covering total costs if the owner is only considering explicit costs If implicit costs exceed the difference between revenue and explicit costs, the business is not able to cover its total costs

Profits incorporate all business expenses, including depreciation Depreciation doesn’t take cash out of your business; it’s an accounting concept that reduces the value of depreciable assets So depreciation reduces profits, but not cash Inventory and cost of goods sold also affect profits, but not necessarily cash

So, we can think of normal profit as being the minimum return, or cost, that is necessary to keep the firm running The size of the firm is fixed in the short run In the long run, all the resources are variable That is, the quantities of all resources can change to alter the firm’s level of output

The standard for profitability requires that income derived from the company’s business activities exceeds the company’s expenses While a company can be solvent and not profitable, it cannot be profitable without solvency

Profitability refers to profits which the company has made during the year which is calculated as difference between revenue and expense done by the company, whereas liquidity refers to availability of cash with the company at any point of time

To calculate your business’s net profit margin, use the following formula:

1. Net Profit Margin = (Net Income / Revenue) X 100
2. Net Profit Margin = [(Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] X 100
3. Gross Margin = [(Total Revenue – COGS) / Total Revenue] X 100

Profit (Income) is not the same as cash flow Just because your company made a profit doesn’t necessarily mean that your cash increased Therefore, your company can run out of cash by growing too fast as easily as it can from not having enough sales to cover expenses

The key difference between cash flow and profit is that while profit indicates the amount of money left over after all expenses have been paid, cash flow indicates the net flow of cash into and out of a business

Cash (often synonymous with revenue) refers to the amount of money currently or soon-to-be available It’s the money coming into the organization either from investors or direct business activity and serves as the resource to pay expenses Profit is the amount of money left over after all expenses are paid

Running out of money is a common problem for startups and many small businesses It’s one of the worst things that can happen to a business owner Without money, you can’t pay salaries, vendors, or any bills Unless you fix the problem quickly, you could go out of business

A cashflow forecast enables businesses to track the expected cash movements over a period of time in the future Generally speaking, when it comes to future expectations of their profit and loss, business owners tend to know their business inside and out

to finish, use, or sell all of something, so that there is none left: I’ve run out of milk/money/ideas/patience6 päivää sitten

It can be detrimental to your business’ health if you’re making decisions about cash based on your Profits Your business can be profitable but you can definitely run out of cash

Excess cash has 3 negative impacts: It lowers your return on assets It increases your cost of capital It increases overall risk by destroying business value and can create an overly confident management team

A company can still post a loss in its daily operations but have cash available or cash inflows due to various circumstances

Cash can go down even when sales are up due to high levels of accounts receivable, because of the company’s failure to collect “what’s owed to it” from its customers who pay using credit (Investing Answers, nd)

Revenue is the income brought into the company from its main or core business of selling a product or a service Profit can never be more than revenue as per this definition However, companies may have non operating income, those not related to its core activities

However, it’s possible to increase your sales revenues and suffer a profit decrease This can occur if your sales increase comes from higher sales of low-margin items while you suffer a decrease of sales of high-margin products

In summary, increasing sales also bumps up the profit margins