Explicit Cost

What is explicit cost?

Explicit cost is a business expense recorded in a company’s ledgers. Also called an accounting cost, this type of cost is easily recognizable because it results in clear cash outflows. 

When companies have to make business-related payments, such as employee wages, utilities, or advertising, they record these explicit costs immediately for tracking purposes. Organizations need to keep clear records of explicit costs to understand how much of their revenue remains as profit. 

Accounting software supports easy tracking, sorting, and analysis of explicit costs. Businesses use it to keep accurate financial records, maintain a ledger, and create desired reports.  

Explicit Cost Software

Software that mention explicit cost as a feature or term.

think-cell

Types of explicit costs

Business expenditures, both large or small, at any stage of operation fall under the umbrella of explicit costs. Some examples include the following:

1. Salaries or wages are major expenditures for most organizations. Additional methods of compensation, including bonuses and commission payments, are also explicit costs.
2. Mortgage, rent, leases, and other fixed overhead expenses like these must be tracked as direct cash outflow.
3. Utilities, which include bills like water and electricity, are variable, making them harder to estimate than fixed costs. They are still explicit costs because they require payment to a third party. 
4. Raw materials or supplies, another variable explicit cost, must be purchased directly. 
5. Advertising and marketing are considered explicit costs. When companies want to increase sales, they may purchase ad spots on radio, television, or the internet. As with all explicit costs, they must be recorded in the company’s ledger. 
6. Legal fees are direct costs, whether businesses keep a lawyer on retainer or pay for legal fees as they arise. 
7. Miscellaneous expenditures arise for business owners, including taxes, office supplies, and new tools and equipment. 

Importance of tracking explicit costs

Companies carefully monitor explicit costs because they play a key role in their bottom line. Tracking these expenditures helps:

• Clarify expenses: Monitoring explicit costs alerts businesses to cash flow issues. Careful tracking also simplifies reporting for deductions at tax time. 
• Calculate net income: Explicit costs are at the heart of deriving both accounting and economic profit. To calculate accounting profit, subtract explicit costs from the total revenue. To calculate economic profit, subtract explicit and implicit costs from the total revenue. 
• Plan finances: With accurate accounting practices, companies improve their decision-making and financial planning. Expenditures may be fixed or occur in cycles or patterns. Either way, businesses can turn to budgeting and forecasting software to make better decisions about future spending and saving easier. 

Explicit costs vs. implicit costs

Explicit costs are easier to see and record because the cash outflow is directly traceable. On the other hand, implicit costs aren’t trackable as distinct expenditures. Instead, the company allocates resources to one activity rather than using them to earn income from another activity. Also called opportunity costs, these amounts are difficult to quantify and record. 

Many business decisions have both explicit and implicit costs. For example, a new window company may have explicit costs that include product testing and manufacturing. The company records and tracks these expenditures in its accounting software.

At the same time, as a new business with limited time and funds, the company has to hold off on launching its salesperson training program while its beta products are created. This is opportunity cost, and it’s hard to calculate their impact on the company’s bottom line on sales.