So what is Opportunity Cost?
Put simply, if you have a choice of items to purchase and buy the best, then the ‘cost’ is not using the benefits it offers compared to the next best purchase you could have made.
Clear? Probably not! So let’s just say it is about making the best use of scarce resources.
In Real Terms Please…
Let’s say you have a fantastic accounting system, it does your invoicing, gives monthly reports, analyses profits and costs, compares actual performance to plan, chases debtors etc. But, you don’t actually use the system for invoicing and you don’t really read the monthly reports.
The opportunity cost here is more than the cash cost of the system, it is the cost of not using the invoicing (efficiency & cash) and not using the monthly reports (productivity, profits & cost control).
Why Worry About Opportunity Cost?
My belief is that by taking small and bite sized actions, the net effect is much larger, in other words is greater than the sum of its parts.
It is also a common issue found when looking at businesses. There are often systems, purchases, consumables etc, that all have an opportunity cost attached to them. The main questions I like to ask are –
- What are you not using with what you are buying?
- Is there something else cheaper, or more fitting to the business need?
- Would a more expensive option work out cheaper, if you could save elsewhere (cash or time saving)?
- Why are you doing what you are doing?
Remember that when looking at any cost line in a business, go further than simple cash cost. Look at the benefit, value, alternatives available etc.
If you are thinking about reviewing anything in your business then don’t underestimate the benefit of a third party opinion. Lime Consultancy are always happy to offer an external view, if you want to know more then get in touch here, or add your comments above.
By David Farmer