businessman making thumbs up
Also known as opportunity cost, alternative cost is the value associated with the next best course of action that a business might decide to take. Although not recognized by the company as the optimal plan, this secondary cost option essentially provides the company with a backup plan in case the initially taken course of action does not produce the desired results. Since the company has already identified the costs associated with the secondary opportunity, it is much easier to implement the approach when and as needed.
It is important to note that alternative cost is not just about money. The figure also represents a number of other forms of value. For example, the degree of pleasure received from the action is a key factor in determining this type of cost. Another factor is the usefulness of the resulting action, in utility terms. Any benefit that may be derived from the action represents a part of the alternative cost.
The best way to understand how alternative costs work is to consider a person who has a significant amount of money to invest. After researching all available options and taking into account the individual’s general level of comfort with investing, it is determined that the two best options would be to invest the funds in a bond issue or put the money in a certificate of deposit at the bank. local. If the person chooses the CD, the interest that would be earned by issuing the bond represents the alternative cost, or benefit, that was lost by choosing the other option. Also, if the individual chooses to proceed with the bond issue, he forfeits the interest that would be earned on the CD, which represents the alternative cost of this decision.
Alternative or opportunity costs are not about making people doubt their decisions. Instead, the concept helps them determine what to give up in order to make the best possible decision. At the same time, the alternative cost calculation helps qualify each available option and allows you to identify a viable backup plan if the first option does not provide the desired benefit. For example, if the investor who chose to invest in the bond issue decides that the business is not performing as expected, there is always the option of going with a certificate of deposit once the bond issue matures.