Money is finite. If you have $500 to spend, it cannot be spent again (by you) once it’s gone. In this respect, money has much in common with time, and also with spent arrows. None of these opportunities are ever coming back.
When businesses make financial decisions, they are often made upon a “cost versus reward” line of thinking. This is better known as calculating the return on investment (ROI) for any expenditure.
To give an example, let’s say John is contemplating a revamp of his letterhead stationery – it’s old and tired, and the colours don’t really look that good anymore. John asks two printers for quotes and printer one suggests $500 for the redesign while printer two wants $650 to do the same job.
On the face of it, the decision seems straightforward, especially when it concerns something as small and insignificant as stationary, but there is a hidden cost – the opportunity cost of making this decision.
Missing the opportunities
Opportunity cost is an economic term that refers to any financial opportunities one misses when they choose to go in a particular direction. This isn’t only about whether to spend $650 or $500; it’s about whether to spend any money at all.
The question John needs to ask himself is whether he could put this $500 to better use. After all, he can only spend this $500 once. To calculate an answer, John must consider what return he can expect from updating his letterhead and whether this money could be better used on something else entirely.
As it happens, John’s website is only partially finished and the cost of completion is – yep, you guessed it – $500!
If John goes ahead with updating his stationery, there will be no money remaining this month to invest in his website completion. The decision to finish the letterhead will have cost him the opportunity to complete his website.
This opportunity cost scenario can occur in almost every business decision. Often it’s not about whether option A or B is chosen but more a question of whether the expenditure should even be contemplated in the first place or, more to the point, whether it’s a time-critical priority to do it right now.
Sure, John’s stationery can do with a rework but it just might not have to happen right this very month.
All business owners have to prioritise their spending. Do they update their display stands or should they spend money on new lighting? Do the staff room walls need painting or is the selection of watches a little low? This situation probably occurs every day in most stores. Often it comes down to formulating the right question in the first place.
In John’s case, rather than making the assumption that the letterhead needs replacing and then asking, “Who should I hire to do the job?”, he needs to go back one step and ask the question, “What is the best use of my $500 right 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 and missing out on a chance to do something else that could boost bottom line immediately.
This is where the basics of sound cashflow management kick in; the majority of people strike issues with their finances, both professional and personal, because they do not take the time to decide if they should really incur the cost in the first place. It’s as though the money is a hot poker burning a hole in their pocket and it has to be disposed of immediately.
Don’t get ahead of yourself
The trouble is, today’s money doesn’t always correspond with today’s costs. Too often we see business owners getting ahead of themselves because there is a little money in the bank now, and they actually forget about the obligations that they will have to incur tomorrow.
This is particularly bad with stock purchases – where the glitter of diamonds can be so tempting – and easily justified (supposedly) as “investment”.
Unfortunately, not all stock can be easily turned into cash, and furthermore, not all stock will end up fetching the amount that was forecasted.
When weighing up non-priority expenditure, take the time to ask the question, “Do I need to spend this right now?” A little planning will go a long way to ensuring the right decisions are made and the budget is balanced.