The Cost of Saving a Buck

There are many ways to save money.  As small to midsize business (SMB) owners, we can occasionally become a bit obsessed with finding ways of protecting our checkbooks.  But are we truly maximizing our assets when we do things ourselves?

One of the biggest challenges when starting a new business or project is effective cost analysis.  It is important to keep accurate, up-to-date records to understand your costs and return on investments (ROI).  This is where having a good bookkeeper or some basic bookkeeping training will be handy.  However, there are many costs business owners forget to include in their calculations, such as your time, opportunity costs, and sunk costs.

Calculating Time

One of the easier items to calculate quickly, but commonly left out of equations, is the value of your time.  We have all heard the saying, “Time is money.”  That is a great saying, but we have failed to include the most important piece of information… How much money?

The basic answer to this question depends on how much you pay yourself.  Let’s say your billable rate is $50/hour.  In this case, the simplest answer would be that your time is worth about $50/hour or $0.83/minute.

Let’s apply it to a scenario.  You want to save a little money from shipping by driving across town to pick up an item from a vendor.  It is about a fifteen minute drive, so thirty minutes round trip.  Shipping would have been around $17.  Are you saving money by picking the item up?  Not if we are calculating the value of your time.  In this case, you may be better off doing something that is generating that $50 of revenue than driving across town.

Opportunity Cost

Opportunity cost is a much harder item to calculate.  It includes all the variables of the opportunities you lose when you chose one action over another.  The value is more implied in many cases, instead of a direct number like the time calculation.

Let’s use networking as an example.  We already established that you can potentially stay at your business and do activities that directly generate revenue, at your billable rate.  But we also want to make new connections and continually grow the business.  We may be considering attending a small networking event.  There is an opportunity cost either way.  If we go the network event, the opportunity cost is the lost revenue from working through that time.  If we stay at work, then the opportunity cost is the potential additional revenue included from making new connections.

Opportunity costs do get more complicated than this (calculating the cost of the event, for example), and don’t always have hard numbers that you can run for an easier analysis.  But it is important to be aware of opportunity costs when faced with a business decision.  In the end, you will go with what you think is best, and it will either work out or it won’t.  Business ownership includes risk after all.

Sunk Costs

Oddly, sunk costs are the costs we always seem to include in calculations, when we shouldn’t.  Sunk costs are those little expenditures that we made that we cannot recover.  We include these costs in our calculations because we don’t like it when something doesn’t work out, especially when hard earned money is involved.

For example, a new gadget purchased for the business turns out to not run as effectively as originally planned.  It was supposed to improve efficiency, but instead it is a flop, a dud, a liability, and a time sink.  However, we don’t want to replace it because we spent so much time and money trying to get it to work.  This is a sunk cost.  When trying to decide whether to get a new asset, we should not include in our calculations the cost of the one that we are replacing.

Other examples of sunk costs include, non-refundable deposits, employee training, and advertising campaigns. The list goes on and on.  In these cases, it is important to look forward when considering costs in business decisions and not backwards.

 

Have a business or bookkeeping question that you want discussed?  Email it to blog@lighthouse-ledgers.com and it may become the topic of discussion for an upcoming post!

 

This blog is intended to provide informal business and bookkeeping information to educate the general public.  It should not be interpreted as individualized tax, accounting, legal or other business and professional advice.  Always seek the assistance of a professional that is aware of your specific situation prior to taking any action for yourself or your business.