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Improving Profits: What is Opportunity Cost?

12 Aug Improving Profits: What is Opportunity Cost?

Posted at 08:00h in

Bookkeeping & Accounting

by Becky Brown  •  0 Comments

improving-profits-what-is-opportunity-cost.jpgAs a business owner, the task of setting goals for your company rests on your shoulders. Coming up with some of those goals can be a simple task. For example, most business owners have the goal of making a profit and improving that profit over time. But, setting that goal is just the beginning because things get more complicated once you start trying to turn that goal into a reality.

If improving profits is, in fact, one of your goals then the next step is to determine how to improve profits. This is an important part of the process because there is a cost to growing your business and you need to have a true understanding of that cost. Calculating the costs of improving profits and growing your company requires more than a simple equation. You do need to determine the actual costs of doing business such as inventory, payroll, and marketing. But, you also need to evaluate the opportunity cost associated with each area in which you decide to spend money.

Considering opportunity costs, along with actual costs, will help you make the most informed financial decisions for your business. Opportunity cost is simply what it costs you to use your resources for an opportunity. For example, if your business has an extra $100,000 there are several ways that you can use that money. You can invest the money in the stock market and get a return on that investment over time. Or, you can take the money and expand the merchandise offered by your company. If you decide to expand the merchandise then you will have the $100,000 tied up in inventory. The opportunity cost in this situation is the return you miss out on by having the money in inventory instead of investments. You must decide if using the money for merchandise will generate more profit in the long run than leaving the money in the stock market.       

You can also apply the idea of opportunity cost to other areas of your business, such as your time. When you decide to take on a new task, or continue with a task, you can determine the opportunity cost of doing that task. For example, if an essential part of running your business is managing your team, there will be an opportunity cost for anything that takes you away from that duty. If you lock yourself in your office for a couple days once a quarter to work on taxes, you are giving up time that you would otherwise be spending with your team. Is the cost of that missed opportunity lower than the cost of hiring help with your taxes? Would the resource of your time be better spent on other tasks? These are questions you can ask yourself to help you make the best decisions with your time and other resources.

The options for improving the profits of your business are plentiful. It is easy to find ways to use the resources you have available, but not all opportunities are created equal. Some opportunities come with a high cost and a small reward while others pay off big time. You cannot guarantee success with every venture, but considering the opportunity costs will help you make the most informed decision.



Topics: Bookkeeping & Accounting