Explicit costs are direct, out-of-pocket expenses for a business. They include payments for wages, rent, utilities, raw materials, and other operational expenses. These costs are recorded and clearly traceable in the company’s accounting system.
For example, if a business leases a building, the monthly rent is an explicit cost. Similarly, the salary paid to employees or the money spent on purchasing raw materials is considered an explicit cost. They are referred to as “explicit” because they are straightforward and clearly identifiable in the company’s budget.
These costs are in contrast to implicit costs, which are not directly paid out but represent the opportunity cost of using resources that the company already owns. Implicit costs don’t appear on the financial statement but are considered when calculating economic profit.
Example of an Explicit Cost
Let’s consider an example of a small bakery business to illustrate explicit costs.
- Rent: The bakery pays $2,000 per month for renting its shop location. This is an explicit cost as it’s a direct payment made every month.
- Salaries: The bakery has five employees each making $15 per hour. If each employee works 40 hours a week, the weekly payroll would be $3,000, or $12,000 monthly. This is also an explicit cost, as the bakery directly pays this money to its employees.
- Ingredients: The bakery spends about $4,000 per month on ingredients like flour, sugar, eggs, etc. This is another example of an explicit cost.
- Utilities: The cost of electricity, water, and gas used in the bakery amounts to about $500 per month. This is another explicit cost.
- Maintenance and repairs: The bakery spends around $200 per month on average maintaining and repairing its baking equipment. This is also an explicit cost.
When you add all these up, the bakery has explicit costs of $18,700 per month. This is the total amount of money the bakery must spend on direct, out-of-pocket expenses to keep its operations running. These costs can be easily traced and recorded in the bakery’s accounting system.