David Brown: Know Your Hidden Costs
Ask yourself, “Do I really need this now?”
BY DAVID BROWN
Published in the October 2013 issue.
We all understand the concept of cost — the amount you forgo in order to receive a compensating benefit. Often the decisions reached about expenses are taken based on the financial cost — but there is also a hidden cost that isn’t considered.
Money is finite. If you have $500 to spend then once it’s gone you can’t spend it again. It has much in common with time in this regard! Decisions that are made financially are often based on a cost-versusreward basis; often viewed as the return on investment.
To give you an example, let’s say John is contemplating a revamp of his stationery. He has asked two printers to prepare prices for him. Printer one has come back with a quote of $500 for the redesign, while printer two wants $650 to do the same job. On the face of it the decision seems straightforward. But there is a hidden cost — the opportunity cost of making this decision. Opportunity cost is an economic term that refers to what you miss when you make a decision. Given that there is only one allocation of money to spend, what opportunity will John miss if he invests his $500 on redesigning his letterhead?
The question John needs to ask himself is: “Could this $500 be better spent somewhere else?”
As it happens John’s website is only partially finished and the cost of completion is — you guessed it — $500! If John goes ahead with updating his letterhead there will be no money to invest in his website. The decision to finish the letterhead has cost him the opportunity to complete the website.
This sort of question comes up in almost every decision. Often it’s not about whether option A or B is chosen but more the question “Should either choice be even contemplated in the first place?”
All business owners need to prioritize spending. In John’s case, rather than making the assumption the stationery needs replacing and then asking, “Who should I hire to do the job?” he needs to step back and ask, “What’s the best use of my $500 right now?” Know Your Hidden Costs Ask yourself, “Do I really need this now?”
Identifying the opportunity cost in every decision will go a long way to helping make better informed judgments, and earn you a better return on your decision making. If you rush in you may be making a decision that isn’t necessary.
Too often we see business owners getting ahead of themselves because there is a little money in the bank now, and they forget about the obligations they will have to incur tomorrow. This is particularly bad with inventory purchases, where the glitter of diamonds can be so tempting — and easily justified (supposedly) on the basis of “investment.” Unfortunately not all inventory can be easily turned into cash, and often it won’t be for the amount that was paid for it.
Taking the time to ask the question, “Do I need to spend this right now?” will go a long way to ensuring the right decisions are made and the budget is balanced.