The term opportunity costs has an important meaning from both a business and an economic point of view, because these are the so-called waiver costs. Often the opportunity costs are also referred to as the shadow price or waiver costs.
In economics, the opportunity costs describe the lost benefit or the lost profit from an alternative course of action that was waived in favor of the alternative implemented. Colloquially, there is also talk of the cost of lost profits.
At this point it must be emphasized that the opportunity costs are therefore not costs in the sense of cost and performance accounting, but serve exclusively to quantify the missed alternative.
An example of the opportunity cost
A company is founded in which the founder invests 100,000 euros of equity on the one hand – this was previously invested on the stock market – and on the other hand his labor – he was previously employed and had “sold” it for a gross salary of 50,000 euros.
Thus, on the one hand, the founder misses the income such as dividends from the stock investment and on the other hand his salary, which he received in the amount of 50,000 euros.
It is precisely these lost profits that represent the opportunity costs. These should always be taken into account when deciding to start a business . In addition, the opportunity costs may also be included in cost accounting as imputed costs .
Another example of opportunity cost
The purpose of this example is to explain the importance of opportunity costs and how they are calculated.
- Calculation of the opportunity costs for the use of equity
A business founder puts equity of 100,000 euros into the start-up he founded . In the company’s profit and loss account , this equity is not booked as an expense (interest expense), since of course no interest is paid for it – the owner is entitled to the profit.
Nonetheless, there are indirect costs, because the entrepreneur could have invested this 100,000 euros in other ways, for example in fixed deposits or shares, and would have received remuneration for this. It is precisely this lost interest on his capital that the owner has to “earn” with the products of his start-up.
Exactly this remuneration, which the owner misses, is called the opportunity cost. These could be taken into account in cost accounting with the help of an imputed interest rate.
In which areas are the opportunity costs applied?
In business administration, opportunity costs are taken into account in a wide variety of areas and in different ways, such as:
- In cost accounting. Here they are used taking into account the imputed interest, imputed rent or an imputed entrepreneur’s wage.
- In the dynamic investment calculation. Here through the approach of a discount rate, which is used, for example, for discounting with the capital value method.
Two types of opportunity cost
The opportunity costs are differentiated between input and output-related opportunity costs.
- The output-related opportunity costs.
These are exclusively the opportunity costs, which relate to the output of the production process. This means that this means the costs or the lost profit margins of an alternative option that do not relate to the input, but rather to the output of the production process.
In this case, a distinction must be made between alternative costs and optimal costs. The former include the opportunity costs, which deviate from the next best alternative, and the latter include all optimal costs that deviate from an optimal application of the selected alternative option. The alternative costs can then be used when different production programs of the company are to be compared with one another. It is different with the optimal costs, here the evaluation of the alternative is only in the foreground when it comes to the comparison of the optimal production program.
The concept of opportunity costs is often only used when it comes to evaluating the alternative options and, above all, when a decision has already been made. The bottom line is that only an ex-post analysis is possible here.
- The input-related opportunity costs.
These are referred to as costs, the contribution margin of which is limited to the input factor. These include the factors: man hours, material cost or piece. This means that in this context one speaks of the so-called relative contribution margin. Anyone who wants to assess the opportunity costs does not necessarily have to use the contribution margins, but can rather achieve an assessment that the lost customer acquisition, the lost sales or the lost market shares are viewed in relative terms.
In practice, however, the evaluations with reference to the lost coverage amounts occur more frequently, because comparing them is easier and quicker to carry out.
Again briefly summarized
ü Opportunity costs, which are also referred to as waiver or alternative costs, arise from the fact that another opportunity (possibility) is not used.
ü The opportunity costs exist in the national economy as well as in business administration.
ü The transformation curve is a practical example from the national economy as well as the comparative cost advantage. The transformation curve is a graphic that shows a useful ratio of the quantity of goods given an existing use of resources. If the transformation curve rises, then this is referred to as the marginal rate of transformation and this is then the opportunity costs.