Explicit Costs

Published Dec 24, 2022

Definition of Explicit Costs

Explicit costs are defined as costs that require an actual cash outflow. That means they are the costs that are directly visible on a company’s balance sheet. Examples of explicit costs include wages, rent, materials, and other expenses that require an actual payment in cash.

Example

To illustrate this, let’s look at an imaginary ice cream seller called John. On a sunny day, John sells 200 ice cream cones for USD 2.00 each. Thus, his revenue for that day is USD 400.00 (i.e., 200*2). Meanwhile, the ingredients to produce 200 cones add up to USD 150.00 (i.e., variable cost). In addition to that, John has to pay USD 50.00 per day to rent his ice cream truck (i.e., fixed cost). As a result, John’s explicit costs add up to USD 200.00 (i.e., 150 + 50).

Why Explicit Costs Matter

Explicit costs are an essential part of any business. They are the costs that are directly visible on a company’s balance sheet and, therefore directly impact its profitability. That means it is crucial for businesses to keep track of their explicit costs and make sure they are not spending more than they can afford.

Moreover, explicit costs are also important for understanding the difference between economic and accounting profit. That’s because economic profit also takes into account implicit costs, such as opportunity costs, which do not require an actual cash outflow. Thus, to calculate economic profit, it is necessary to first subtract all explicit costs from total revenue.