In accounting, opportunity costs are the potential benefit given up when choosing one choice over the other. Opportunity costs are relevant to future decision making and should not be ignored while making important decisions.
Life is filled with many choices. Every choice has a cost associated with it and we must carefully consider the economic value of the forgone alternative. For instance, if you are taking a two week vacation but you only get paid for one week in your job, then the total cost of taking the vacation is the cost of your travel, hotel, entertainment plus missed pay. The missed pay is a forgone opportunity and becomes a real cost to you when you choose taking a vacation over working. So when you budget for the vacation you want to be sure you include the missed pay as part of the cost of taking the vacation.
Let’s explore the concept of opportunity cost at a deeper level. Have you ever considered the opportunity cost of not pursuing your dreams? Yes, things might not work out if you venture out but what is the real cost of doing nothing or even worse playing it safe. Life is full of choices and our choices of today are the realities of tomorrow. There is so much liberation in answering to your calling. A person who answers to their calling is a person who lives with purpose. They live from a place of decisiveness rather than impulsiveness which is where you find majority of people. If you play it safe in life you miss out on a lot of what life could possible offer you.
Application to business
So how can we apply this principle in our business life?
As you grow your business there will be lots of opportunities presented to you. And most of them will sound like real good profitable options. However, your choice to invest in other business opportunities should be aligned with your purpose and not money. Money comes and goes but purpose transcends over multiple deals/ businesses. When you invest your time, efforts and money in a deal that does not align into your purpose, you lose interest and feel drained whenever you have to focus any energy on the deal.
To be consistent with your purpose, you need to remind yourself everyday what your purpose is. Write it and post it on your mirror. This way you are consistently reminded why you do what you do. Anything that takes you away from your purpose comes with a big price tag.
When you are laser focused on what needs to be accomplished and what deals to accept, money only becomes a secondary measurement tool. Money is never a good enough reason to engage in a new business venture. The lure of money quickly fades away once you have achieved it. Money always leaves you feeling like there is got to be more to this. The opportunity cost of engaging in project for money is a lack of fulfillment.
Business owners tend to overlook the opportunity costs. They often treat it like it is less important because it is not a direct out of pocket costs. Even though opportunity cost is a “forgone opportunity” it is very real because it is something that could have happened if you chose differently. Opportunity cost does not affect only your dollars, but your energy and productive level. Opportunity costs are very real and important to making good decisions. Counting the full costs which includes the opportunity costs keeps you laser focused on what needs to be accomplished.
So now we understand the concept of opportunity costs how can we use it to make decisions? In my line of business, I get calls every day from vendors proposing a new product or service I should use with my clients. How do I know which ones are good for me and which ones to ignore?
Below are 5 quick steps I follow:
Clarify the problem: First I try to figure out what problem the vendor is trying to solve. Then I relate it to my business to see if it is a problem I need solved in my business.
Specify objectives: If the problem from above is one I am contending with, I specify how this solution could help me reach my predefined objectives. If you do not have objectives for your business, you allow others to define it for you.
Look for alternatives: Are there other solutions to this problem. This is where the concept of opportunity costs is applied. Because you make a decision to the exclusion of others
Do a cost/ benefit analysis: I create a chart with the cost and benefits of each option.
Choose the best fit: Finally, I choose the one which best fits/ align with my business purpose. If there is more than one option, I use cost as a secondary measure.
Making the wrong choice not only affects your cash flow but your energy level which is why cost is not my primary tool of measurement. As a business owner, my time is my most precious resource and I want solutions that maximize my time.
Are you purposeful in your life? Do you count the full cost of your everyday choices. Our choices of today are our destination of tomorrow. A ball thrown up will always fall down: An unplanned life will always lead nowhere.
So where are you going? Do you have plans for a destination or do you let the wind blow you wherever it will. Investing your time decisively rather than following impulses makes you a more successful person. How you spend your time and money tells a lot about you and learning to invest wisely by counting the opportunity costs is a starting point.
At Lifestyle CPA, I can show you how to properly identify opportunity costs and better weigh your options.