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Explicit costs have a direct effect on a business and on the amount of money a business has available. This lesson explains explicit costs and gives two different examples of explicit costs in a business.

What Are Explicit Costs?

Explicit costs are expenses that require a payment to be made. They lower the amount of cash and money your business has available and include items like payroll, rent, supplies, marketing, etc. These are expenses that require a check be written or payment made to cover the costs.Much like a personal budget, explicit costs in a business must be managed and may need to be cut if revenue decreases.

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For instance, if business is slow or sales are down, smaller amounts of inventory may be ordered or fewer staff hours may be needed. These cuts will affect the total explicit costs. However, there are other costs that you may not be able to cut. If you shorten your business hours, you may save money on payroll and expenses, but you will still have rent, insurance, and other set explicit costs that must be paid.

Examples of Explicit Costs

Let’s say you own a small pizzeria where you serve pizza, pasta, salad, drinks, and various desserts. You have a thriving business with 5 full-time and 3 part-time employees. You invested in the best pizza ovens, equipment, and furniture to ensure you had the best shop in town.

At the end of the month, you pay your bills and update your financial records. You write checks for pizza supplies, payroll, rent, utilities, and equipment loan payments. These are all explicit costs because they are measurable and require a payment for a specific amount of money.Let’s look at another example. You have just started your business as a small business accountant. You do bookkeeping, taxes, and payroll for small businesses.

You find yourself doing some work for clients that you don’t bill for because you want to build loyalty with customers and grow your business.When you calculate your billable time at the end of the week, you see you have 45 hours of billable time and 4 hours of non-billable time. The non-billable time is a combination of free work you did for clients and work you did to operate your business, such as getting a repairman to come fix the air conditioning and interviewing a new receptionist.Because your time is what generates income for the business, yet the activities you are performing are not charged to anyone or any business, the lost time is an expense to your business. This lost time is not considered an explicit expense, though. This cost is part of the opportunity costs, or loss of income to the business because those hours were spent on activities that were not billed but were spent on unpaid activities.

However, the cost of the air conditioning repair is an explicit cost, as is the pay check you will give the new receptionist.

Lesson Summary

As a business owner, understanding and managing explicit costs is an important function. Explicit costs take money out of your company and affect cash flow. Examples of explicit costs include rent, utilities, payroll, equipment, supplies, and anything that you must pay for.

Explicit costs do not include opportunity costs.

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