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Take advantage of our Free Dynamics of Economical Cost Guide

What is Economical Cost? Put simply, economical cost is a concept which will tell you how much money you have given up by making a different choice. As an example, an individual earning an annual salary of $100k decides to open his own business and earns $50k in the first year. If he continued to work in his original job he would have increased his wealth by $100k instead of only $50k. The $100k is the economical cost that he has given up by choosing to work only in his own business. When he uses his profit of $S0k, minus the economical cost $100k. He is actually worse off by $50k working in his own business.

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In the following situations you might find the dynamics of economical cost relevant to you:

  • If you are running a business, understanding your economical cost is critical to you maximising your real profit. Accounting profit ignores what you have sacrificed if you have applied your time or resources elsewhere. Go through your own time1 finances and assets to see whether your business is really earning the best profit for you.

For example, if you have invested $100k into a business and are earning $2k accounting profit after all expenses (including a salary to you of $60K). Is the business earning you good profit? If you can earn more than $60K in a different job, it might not be a good investment, since the current bank interest rate could be more than 3%. And if you found a different job and had saved the money in the bank, it would have earned you $3k instead of only $2K. By choosing to stay in your own business1 you are worse off by $1K per year.

  • Understanding economical cost will help you to understand your real cost when you purchase an item at home.

For example, if you decided to use money in your mortgage offset account and the cost is $S0k. You might think you only need to consider the cost of $SOK. However, remember if you can leave the money in the offset account, you are saving $43K interest for a 30 year home loan on 4.8% interest rate. You can use the mortgage calculator on our website to do the calculation yourself. At the same time, if you don’t purchase a car, you could be paying $3k per year on Taxi expenses. This would mean a $21k saving if you only used the car for 7 years. In the purchasing of a car there are many scenarios and factors you need to consider other than just the cost of the car.

Of course, in our examples we didn’t mention the pros and cons that are not in dollar value. Of course It could be more flexible and rewarding to own your business and more convenient to have your car! The main purpose of understanding economical cost is so that you understand what you are really giving up for the benefits, helping you make a sound ‘financial decision.

There are other areas in which you can utilise the concept of economical cost. Remember at any time no matter how you are using your time and resources, there are always other scenarios that could generate some income for you. Compare the other scenarios so that you can understand your real cost at any time. 

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Declaration: We hope this information and these files will be useful to you. Remember, this article has been prepared without specific knowledge of your financial situation. Before making financial decisions or plans be sure to consult with an Accountant or a Financial Advisor.

Declaration: The Excel files and content of this website have been prepared without taking into account your personal financial situation or knowledge of your financial needs. Impact Taxation and Financial Services cannot be liable for any losses or damages arising from using the information provided. It is the user’s responsibility to seek independent advice from a professional accountant before implementing any financial plan.