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Blog heOne of the most important things to consider when evaluating opportunities is the cost.

Opportunity Cost, is a business concept that really applies to all areas of life.

The basic concept is that there is a limited resource like time or money and a number of ways to spend or invest it.

For example you have a 3 day weekend. Your choices are to go boating with family and friends or putting in that extra effort to get a job completed for work.

If you choose the first option, you take advantage of the great opportunity to enjoy the outing. But it comes at the cost of high stress, possible job demotion or job loss.

We make these kinds of decisions all the time. When well informed, we realize the consequences of our actions and decide accordingly. In hindsight, we may not always make the best decision, but we generally make the best decision we can for the state of mind we are in at the moment.

So what does this have to do with finance or running a small shop?


Good question. Opportunity cost in business is a measure of what a particular opportunity may cost a business.

In the most simple terms, suppose your company has a limited budget. Easy enough, I suspect.

Within the reaches of that budget are the following:

• A new CNC Lathe for which you think you can find plenty of work
• A marketing campaign to attract new business from local businesses
• A part time employee to take care of bookwork or deburr parts
• Bonuses for your best employees

Any of the above would be a good opportunity for your business, but when you pick one, you do so at the cost of excluding the others.

If you get the new lathe and the work to go with it, you may find yourself working late at night to keep the machine running because, in the short term, you can not afford an employee to run it.

Your marketing campaign may be great and bring in new business, but you may be lacking the equipment to do the work people want. Eventually the new prospects forget about you because you do not have the capacity to do their work.

And so on.

In finance it gets interesting as well. Suppose you completed a large job and now have $50,000 in the bank. What do you do with it?

• You could put it in savings at a nominal interest rate in this market say 2%
• You could pay off some supplier or other debt that may be costing you 10% or more
• You could buy a new piece of equipment
• You could use the money for a down payment on your own building

If you choose to save the money at 2% you do so at the cost of 10% interest on the outstanding loan. But by the same token, with the cash in the bank, you have the liquidity to buy future raw materials without incurring more debt.

If you pay off the debt, you improve your standing with those particular vendors, but by eliminating an important asset, you may find it harder to get future credit for a large project.

If you buy the new piece of equipment, it may produce far more income than could ever be earned in a bank. Or, it could sit mostly idle for months or years until you get the word out about your expanded capacity.

I have worked for a couple of companies where some of my colleagues could not fathom why "management" did not fund their particular project. In many cases they failed to realize that the decision makers had a lot of "opportunities" from which to choose.

Had my colleagues looked around and evaluated the opportunities with which the managers were faced, they may have made different decisions themselves. For example, they may have chosen a different presentation style that was supported with substantial return on investment data. This would have given the managers an entirely different perspective on the proposed project.

Or, they may have chosen to join forces with those promoting a competing opportunity to build a strong case that supported both of their initiatives.

Or they may have waited for a more opportune time before they put the time and effort into getting funding for their pet project.

We recently added central air conditioning to a house we have been renovating. Chances are we will never recover the cost of the installation. But while we are living in the house we are far more comfortable. Our oppourtunity for comfort comes at the cost of return on our investment. For me, it was a decision that was easy to make. :-)re.