Firms must think not only about the revenues but also the costs incurred during business operations. Costs are essential to every corporation’s budget because if the finances are spent inefficiently, the firm will go bankrupt. To make effective business decisions, the company’s head must understand the entrepreneurial activity’s costs.
To understand all kinds of costs thoroughly, it is essential to analyze them:
- Differential costs – an essential factor in organizations’ decision-making process that aspires to improve the business model. This concept is closely related to marginal costs and can be applied to fixed or variable costs of an enterprise (Proag, 2020). It is an indicator that allows the managers to conclude how effective their decision was (Taschner & Charifzadeh, 2020). The effectiveness of business decisions needs to understand how to study those costs.
- Alternative costs – expenses of production of the goods and services measured by the cost of the best-missed opportunity to use the factors of production spent on their creation. Alternative production costs are the main driving motive for producers to maximize their profits (Proag, 2020). Thus, by understanding this type of cost, company management will assess the risks of foregone benefits and opportunities lost or sacrificed when choosing one alternative course of action requires abandoning another.
- The company incurs sunk costs that it will no longer be able to recover in any way. While deciding whether to continue investing in the current project, sunk costs should not be considered because these costs cannot be recovered (Proag, 2020). However, many executives continue to invest in projects because of the enormous amount of money already invested in the past (Proag, 2020). This is done to avoid losing the investment when the project closes and proves unprofitable (Taschner & Charifzadeh, 2020). In a rational approach, companies should consider past investments as sunk costs and exclude them when deciding whether to proceed with further investments.
To summarize, each type of cost is significant for decision-making. To achieve the effectiveness of business decisions, it is necessary to study and understand each of them carefully, not prioritizing only one type. From every kind of cost, the firm can conclude that all costs have a predictive factor, which allows for preventing unnecessary costs in the future, and rehabilitative, which enables to recover of lost funds by making prudent effective decisions.
Proag, V. (2020). Infrastructure planning and management: An integrated approach. Springer International Publishing.
Taschner, A., Charifzadeh, M. (2020). Management and cost accounting. Tools and concepts in a Central European context. Wiley.