The Wise Entrepreneur

Why an Entrepreneur Must Understand Opportunity Costs

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First of all, please accept my apologies for the inability to share some information over last week, basically due to unavoidable circumstances. Today let’s briefly consider the concept of opportunity costs. This is a somewhat not very common concept but I believe we will appreciate the importance to an entrepreneur by the time we close this brief article.

In its very basic form, opportunity cost is what you lose by choosing an alternative. It is the cost of choosing one option to another. As an example, what do you lose by financing your business with your own money instead of using borrowed money? What do you forego by outright purchase of an asset rather than leasing it? What do you lose by producing your products in your small manufacturing outfit instead of outsourcing production?

I guess many of us entrepreneurs do not even give a thought to these costs many times we make decisions. Yes – and more so due to the fact that such costs are not easy to quantify, and belong to the future. We get so occupied with actuals and budgets and forget about such costs. Moreover, such costs are off balance sheet – in other words they are not accounted for and so it’s easy to forget or ignore them.

Do you know that total cost equals financial costs plus opportunity costs? Let’s be honest ladies and gentlemen. How many of us really go beyond financial costs when doing our numbers? Now, your costs that comprise only financial costs are not true or real costs, simply because there is more to it. However good you are at costing, if you don’t consider opportunity costs in your decision making, you might be missing some very good things. Period!

Every decision we make is a trade-off. As decision making is almost a daily part of an entrepreneur’s life, opportunity costs cannot be avoided. Don’t you think so? Therefore, what are some of the vital things we entrepreneurs need to understand about opportunity costs? Why must an entrepreneur understand the concept of opportunity costs? Let’s briefly mention some of the issues down here.

  • You are poised to have a better financial footing with knowledge of opportunity costs. As an entrepreneur, when you understand, appreciate and make us of opportunity costs, you will endeavor to minimize your opportunity costs and hence maximize what you get from your resources. In other words, understand the opportunity costs of decisions you make, and find options to keep these costs as low as possible. Doesn’t this sound good? Better profits, better cash flow and bank balances etc. I guess you understand this common language of money. I know you might ask me how to get this done, but the technicalities might be too detailed for this write-up.
  • Inability to apply this principle leads to missed opportunities for future growth, savings etc. For example, you might be renting premises for your business operations. Rental costs might be rising by the year but you are locked into the narrow thinking that you simply continue negotiating rent always, or consider moving location to a cheaper facility. You don’t consider what you are missing by renting and not purchasing and owning your premise. What are you losing by renting? You are losing costs savings. You are losing capital allowances on the qualifying owned property, which could make you pay less tax etc. As another example, you might decide to continue using those antiquated machinery you inherited from your father’s business, instead of outsourcing the production and save tens of thousands of dollars per annum. If you have heard of or experienced those breakdowns that make people lose days of production, yet with inability to get replacement parts because the machinery model is out of support, you get what I mean!
  • Additionally, you should be able to focus on what you do best when you understand this concept of opportunity costs. Don’t you think so? When you critically analyze your enterprise operations in light of opportunity costs, you will certainly see windows of comparative and competitive advantage and specialization. Now, these are the things that can differentiate you from those competitors, and give you an edge in business. Isn’t it? Some entrepreneurs are so hopelessly worried of competition for no good reasons. When competition gets tough you simply tune up to a tough posture and then the tough you gets going. Iron sharpens iron.

Well, I think we should stop here for today. Nevertheless, within and beyond entrepreneurship, this concept of opportunity cost is so vital. I leave it to you to decide. You can chose to utilize the principle – that is if you are not yet there – or simply ignore it. At the end of the day it’s your business. Isn’t it? Deep within me I know that every genuine entrepreneur desires good financial footing, strategic ability to take advantage of opportunities and comparative including competitive advantage. Great weekend!

Till then,

The Wise Entrepreneur

Picture of Clayton W. L. Mwaka

Clayton W. L. Mwaka

Clayton W. L. Mwaka, a Ugandan chartered accountant and motivational speaker with 24 years of diverse experience, specializes in business administration, international consultancy, and lecturing. He advocates for personal empowerment through balanced living, qualitative leadership, and paradigm shifts, aiming to unlock individual potential globally.

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