To Spend or Not to Spend: The Importance of Opportunity Cost Among Small Businesses

 

opportunity cost articles

Opportunity cost, In economic terms, the opportunities forgone in the choice of one expenditure over others. For a consumer with a fixed income, the opportunity cost of buying a new dishwasher might be the value of a vacation trip never taken or several suits of clothes unbought. The concept of. Sep 01,  · The opportunity cost of trying to teach our students an encyclopedic list of technical topics, it seems, has been failure to achieve that goal. As Author: Robert H. Frank. The latest news, videos, and discussion topics on opportunity cost - Entrepreneur.


Opportunity Cost Definition


Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another. Because by definition they are unseen, opportunity costs can be easily overlooked if one is not careful. Understanding the potential missed opportunities foregone by choosing one investment over another allows for better decision-making. The formula for calculating an opportunity cost is simply the difference between the expected returns of each option.

Say that you have option A, opportunity cost articles, to invest in the stock market hoping to generate capital gain returns. Option B is to reinvest your money back into the business, expecting that newer equipment will increase production efficiency, leading to lower operational expenses and a higher profit margin.

Assume the expected return on investment in the stock market is 12 percent over the next year, and your company expects the equipment update to generate a 10 percent return over the same period. In other words, by investing in the business, you would forgo the opportunity to earn a higher return, opportunity cost articles.

Opportunity cost analysis also plays a crucial role in determining a business's capital structure. While both debt and equity require expense to compensate lenders and shareholders for the risk of investment, each also carries an opportunity cost. Opportunity cost articles company must decide if the expansion made by the leveraging power of debt will generate greater profits than it could make through investments.

Because opportunity cost is a forward-looking calculation, the actual rate of return for both options is unknown, opportunity cost articles.

Assume the company in the above example foregoes new equipment and invests in the stock market instead. It is equally possible that, had the company chosen new equipment, opportunity cost articles, there would be no effect on production efficiency, and profits would remain stable. It is important to compare investment options opportunity cost articles have a similar risk. Government backs the rate of return of the T-bill, opportunity cost articles, while there is no such guarantee in the stock market.

When assessing the potential profitability of various investments, businesses look for the option that is likely to yield the greatest return. Often, they can determine this by looking at the expected rate of return for an investment vehicle, opportunity cost articles.

However, businesses must also consider the opportunity cost of each option, opportunity cost articles. Assume that, given a set amount of money for investment, a business must choose between investing funds in securities or using it to purchase new equipment. The difference between an opportunity cost and a sunk cost is the difference between money already spent and potential returns not earned on an investment because the capital was opportunity cost articles elsewhere.

This is the amount of money paid out to make an investment, and getting that money back requires liquidating stock at or above the purchase price. From an accounting perspective, a sunk cost could also refer to the initial outlay to purchase an expensive piece of heavy equipment, which might be amortized over time, but which is sunk in the sense that you won't be getting it back.

Again, an opportunity cost describes the returns that one could have earned if he or she invested the money in another instrument. As an investor that has already sunk money into investments, you might find another investment that promises greater returns. The opportunity cost of holding the underperforming asset may rise to opportunity cost articles the rational investment option is to sell and invest in the more promising investment, opportunity cost articles. In economics, risk describes the possibility that an investment's actual and projected returns are different and that the investor loses some or all of the principal.

Opportunity cost concerns the possibility that the returns of a chosen investment are lower than the returns of a forgone investment, opportunity cost articles. The key difference is that risk compares the actual performance of an investment against the projected performance of the same investment, while opportunity cost compares the actual performance of an investment against the actual performance opportunity cost articles different investment.

Still, one could consider opportunity costs when deciding between two risk profiles. And if it fails, then the opportunity cost of going with option B will be salient. When making big decisions like buying a home or starting a businessyou will probably scrupulously research the pros and cons of your financial decision, but most day-to-day choices aren't made with a full understanding of the potential opportunity costs.

If they're cautious about a purchase, many people just look at their savings account and check their balance before spending money. Often, people don't think about the things they must give up when they make those decisions. The problem comes up when you never look at what else you could do with your money or buy things without considering the lost opportunities.

Having takeout for lunch occasionally can opportunity cost articles a wise decision, especially if it gets you out of the office for a much-needed break. However, buying one cheeseburger every day for the next 25 years could lead to several missed opportunities. This is a simple example, but the core message holds true for a variety of situations.

It may sound like overkill to think about opportunity costs every time you want to buy a candy bar or go on vacation. Even clipping coupons versus going to the supermarket empty-handed is an example of an opportunity cost unless the time used to clip coupons is better spent working in a more profitable venture than the savings promised by the coupons.

Opportunity costs are everywhere and occur with every decision made, big or small. Financial Analysis. Financial Ratios. Fixed Income Essentials. Your Money. Personal Finance. Your Practice. Popular Courses. Login Newsletters. Business Business Essentials. Table of Contents Expand. What Is Opportunity Cost? Formula and Calculation. Cost and Capital Structure. Comparing Investments.

Opportunity Cost vs. Sunk Cost. Risk vs. Opportunity Cost. Example of Opportunity Cost. Opportunity cost articles Takeaways Opportunity cost is the return of a foregone option less the return on your chosen option. Considering opportunity costs can guide you to more profitable decision-making.

You must assess the relative risk of each option in addition to its potential returns. Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Terms Incremental Analysis: How Companies Decide Between Two Opportunity cost articles Incremental analysis is a decision-making technique used in business to determine the true cost difference between alternatives.

Understanding Why Mutually Exclusive Events Cannot Occur Simultaneously Mutually exclusive is a statistical term describing two or more events that cannot occur simultaneously. These events may also be independent events that have no impact on the viability of other options. How Cost-Benefit Analysis Process Is Performed A cost-benefit analysis is a process used to measure the opportunity cost articles of a decision or taking action minus the costs associated opportunity cost articles taking that action.

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Understanding Opportunity Cost: How $ Sneakers Could Cost You $75, | HuffPost

 

opportunity cost articles

 

The latest news, videos, and discussion topics on opportunity cost - Entrepreneur. Opportunity Costs: The True Price of Internships Opportunity Costs: The True Price of Internships. A “flexible” corporation requires flexible workers, and as the labor market has shifted, so have the conditions placed on its participants. Flexibility doesn’t just manifest itself in global economic trends. Sep 19,  · A common example of opportunity cost for small business owners occurs when they ask themselves: Should I strategically save money to have it available for future use, or should I Author: Firas Kittaneh.