What is opportunity cost? Characteristics, meaning, and method of calculating opportunity costs

Opportunity cost is an important factor affecting the decision-making process of a business. Opportunity costs appear in situations where choices need to be made between multiple options. So what is opportunity cost ? How to calculate specific opportunity costs ? Let's find out with 1C Vietnam in the article below!

1. What is opportunity cost? Example of opportunity cost

Opportunity costs are the potential benefits that a business may forgo when choosing one option over another. Opportunity costs are not always expressed in money but also include factors such as effort, effort, and time spent by the subject.

Below is an example of opportunity costs in business so businesses can better understand. Typically, a business has working capital of about 5 billion and wants to invest. Businesses are faced with the choice of expanding the factory to increase output and product quality or buying stocks to make a profit. In the context that the risk level of both options is equivalent, if the business chooses to expand the factory, the opportunity cost is 15% of the return rate of investing 5 billion in stocks.

2. Classify opportunity costs

Opportunity costs include all benefits foregone by choosing one of several possible alternatives. This cost can be divided into explicit opportunity costs and hidden opportunity costs. Specifically:

• Existing opportunity costs are expressed in terms of monetary payments, reflecting the direct costs of the decision. This expense often appears in cases where businesses use input resources such as renting materials, salaries, rent, etc.
• Implicit opportunity costs are the indirect costs of choosing an alternative. This type of fee is often evident when a business uses its resources for other purposes, including the cost of forgoing the best option.

3. Opportunity cost characteristics

So how to distinguish opportunity costs from other types of costs in a business. Below are some characteristics that 1C Vietnam has compiled to help businesses better understand this concept.

3.1 Opportunity costs are not costs that have already been incurred

Opportunity costs are not calculated based on costs that occurred in the past or actual expenditures. Instead, opportunity costs are estimated based on currently available information about the firm's likely future decisions.

3.2 Opportunity cost is the basis for decision making

When making a decision, businesses must consider missed opportunity costs . For example: A business makes a decision to invest in machinery, then the business ignores the opportunity cost of promoting communication, employee training, etc.

3.3 Opportunity costs cannot be determined with certainty

When considering opportunity costs , businesses must calculate all benefits, including benefits that are not expressed in monetary form. Specifically:

• Time: How much time can businesses save if they choose to invest in machinery instead of improving workers' skills;
• Price: For die casting businesses, choosing cheap materials for production will minimize input costs but may create maintenance problems in the future.

3.4 Opportunity costs are not shown on financial statements

While labor, factory, and machinery investment costs are clearly accounted for in financial statements, businesses cannot record opportunity costs this way. With its uncertain nature, estimated based on decisions that may occur in the future, it is difficult for businesses to clearly record opportunity costs in financial statements.

4. What does opportunity cost mean in business?

Opportunity costs play an important role in business activities, especially the decision-making process of business administrators.

• Opportunity costs help businesses compare the gains and losses when choosing, thereby knowing how to use resources effectively.
• Businesses often make the most of their available resources with the desire to achieve the highest efficiency at work. However, no resource is infinite, so opportunity costs will help businesses invest effectively and limit risks.

5. How to calculate opportunity costs accurately

Opportunity cost is also determined using the following formula:

Opportunity cost (OC) = FO – CO

In there:

• FO: Hidden opportunity cost is the benefit from the best option that was overlooked;
• CO: Part of the benefits from the chosen option or the existing costs.

6. Advantages and disadvantages of opportunity costs

The benefits of opportunity cost can be clearly seen in helping businesses make business decisions. However, in reality, this type of cost also has certain disadvantages. Let's study the table below to understand the advantages and disadvantages of opportunity costs !

7. Effectively manage opportunity costs with 1C:Company Management software

To manage opportunity costs effectively, businesses can use 1C:Company Management software. The software connects departments and departments of Sales - Purchasing - Production - Warehouse - Finance - Human Resources and Salary - CRM together, comprehensively managing the business. 1C:Company Management allows recording transactions and cash flows of businesses accurately, scientifically and systematically. All information data is stored scientifically, helping administrators easily evaluate, compare, and overcome the disadvantages of opportunity costs.

In addition, the software also has the ability to create financial reports and record business activities in detail to serve as a basis for administrators' assessments and decisions. With specialized financial management features, 1C:Company Management will effectively support administrators in controlling this type of cost that is somewhat difficult to measure.

Opportunity cost refers to the benefits a business misses out on when choosing one option over another. This type of cost has unique characteristics and is often not recorded in financial statements. However, opportunity costs do influence managers' decisions. Hopefully your business has had more useful information. If you want to learn more about 1C:Company Management software, please contact 1C Vietnam for support.