What are hidden costs? Examples, ways to calculate and cut hidden costs

Hidden costs are important factors contributing to the economic profit of a business. From there, businesses will be able to adjust business strategies in the right direction. In the article below, Viindoo will provide readers with information related to these common hidden costs.

What are hidden costs? Examples of hidden costs

Hidden costs, also known as conversion costs or opportunity costs, is the cost that arises when a company uses internal resources toward a project without any explicit compensation for the utilization of resources. For example, when a company uses a car for internal purposes such as transporting executives, that business loses the opportunity to lease that car to make a profit. 

Hidden costs are thereby considered a loss of money because a business uses an asset instead of selling it or leasing it back. The calculation of this cost will also be based on the market value in case the asset is used for other purposes. As in the example above, the company's opportunity cost would be the amount it would receive if the business leased the car.

View Details: What is business management cost? Optimal Cost Management

Differentiating Implicit and Explicit Costs

Businesses need to distinguish between implicit and explicit costs. In fact, opportunity costs are not a direct cash flow from operating activities and should not be included in the financial statements. However, this cost needs to be carefully considered when it comes to developing a strategy for the company.

Contrary to implicit costs, explicit costs, or expenses are tangible costs that the company must pay in order to maintain production and business activities. Readers may come across many expenses that are currently published by businesses, such as employee salaries, factory rents, purchase of machinery and equipment, etc.

implicit and explicit costs
There is a fundamental difference between the explicit cost and implicit cost.

When preparing financial statements such as balance sheets or income statements, a company needs to consider all current expenses. Accounting profit will also be calculated by subtracting current costs and depreciation from sales. The final number will be the basis for leaders to judge whether the business situation is stable or not.

However, calculating an organization's profit requires consideration of both hidden costs and explicit costs. Specifically, profit will be determined by subtracting explicit costs and opportunity costs from total revenue. In fact, economic profit will reflect the performance of a business more accurately than the number on the books of accounts.

How to calculate hidden costs

The business situation of businesses is different, so it is difficult to determine how to calculate hidden costs. The company needs to consider all factors related to its assets and consider the conversion cost for each item. These factors will determine the specific amount used to calculate economic profit later. Ideally, companies consider all the resources that have been used to deliver the product/service to the customer.

For example, the business is using a building for office use. If this house is rented, the owner can earn 20-30M VND per month. Therefore, in this case, the hidden cost of using the building will be 20-30M.

Some common hidden costs in business

In business operations, there are many types of hidden costs that can arise. Business people must know how to distinguish each type of opportunity cost, thereby devising appropriate strategies to reduce them. The following are the most common types of conversion costs found in most companies.

Hidden costs of not managing employee performance​

A common problem that appears in many businesses is that employees are distracted while working. Employees may not achieve optimal performance due to many factors such as: being distracted, losing motivation, not feeling connected to the organization, etc. Once this problem occurs, the company will have to spend an intangible cost that leads to an inefficient business.

Hidden costs of not managing employee performance
Employee performance determines the effectiveness of the organization's performance.

Hidden costs due to cumbersome processes​

This is an extremely important cost but is overlooked by many companies. Several studies have shown that most employees spend too much time performing repetitive tasks. This comes from the fact that the business does not have an optimal operating model. As a result, wasting time due to cumbersome processes will make the company inefficient and cause revenue loss.

Meeting costs ​

Meetings that take place regularly in the organization also consume a significant amount of money. Attending too many meetings leaves employees no time to handle other tasks, which implies hidden costs. Companies should consider the time and frequency of meetings to limit unnecessary expenses.

Hidden costs of meetings
Too many meetings can have a negative effect.

Idle resources cost ​

Idle resource costs appear in many production and business enterprises. This cost not only refers to machinery and equipment but also to human resources in the organization. This cost will reduce the efficiency of the business.

For example, when a worker spends too much time performing manual tasks, the employee will not be able to handle other requests. Some studies have shown that in the case of businesses that automate only 25-40%, workers will lose about 22% of their working time to handling repetitive tasks.

Overtime costs​

Working overtime is not always a way to help a company improve performance. Sometimes, overload can drain employee morale, making them unable to complete assigned tasks well. In addition, the employee's stay overtime also costs the business a certain amount of money for the cost of electricity, water, machinery, and equipment. Therefore, organizations should consider dividing the amount of work per capita reasonably.

Hidden costs come from hard-to-control parts​

For large corporations, it's not easy to coordinate and control among departments. In particular, for departments that do not have clear KPIs or OKRs, it is impossible to track the work progress of the employees working there. More seriously, once the business has loose control, the mistake of one department can affect other departments. In the long run, this will make the business less efficient.

The lack of control between departments causes hidden costs
The lack of control between departments causes hidden costs.

Debt costs​

Startups without strong financial resources often rely on loans to run the business. However, if the lending institution has a bad credit score, the terms of the contract will be extremely unfavorable. 

Moreover, it is also difficult for businesses to generate enough profits to pay off debts. Once interest payments are delayed, your credit score can worsen and affect your ability to borrow money in the future.

Hidden costs due to the use of separate software​

In the early stages of operation, businesses often use separate software to handle these problems. However, this can cause data inconsistency among departments, and it would take a long time to resolve arising issues. Besides, once businesses want to expand, they will have to buy more advanced software, which cost a lot of money for frequent replacement.

How to minimize hidden costs for businesses?

After having a basic understanding what are hidden costs, companies also need to learn how to reduce these costs to optimize the performance of the organization. Here are a few possible options.

Evaluate, measure, and optimize workflow​

Each business will have a unique way of operating. Organizations need to regularly evaluate the effectiveness of business processes to make timely improvement plans, avoiding resource loss. The BPM Life Cycle model will help companies build and manage their processes:

  • Design: Design effective workflows for the organization.
  • Modeling: Modeling the necessary processes to ensure work performance.
  • Execution: Use facilities to monitor and control the process.
  • Monitoring: Regularly monitor the working process of employees, and evaluate the effectiveness of the working team.
  • Optimization: Adjust and optimize the process.
Companies need to regularly reassess existing processes to reduce hidden costs
Companies need to regularly reassess existing processes.

Process Performance Indicators (PPIs) have been designed to measure the effectiveness of a manufacturing process in an enterprise. These indicators include 3 main groups, which can be mentioned as

  • Output quality index group (products/services): Depending on each individual indicator, this index will also have a measurement form. separate measure. In most cases, though, this metric will be determined by Customer Satisfaction
  • Time index group: The time to complete the job and deliver value to the consumer.
  • Cost index group: Calculated based on different types of costs between inputs and outputs; repair costs due to errors/damages in the process.

Measure employee performance​

Employees are the people who directly create products and services and have an important influence on the performance of the organization. Therefore, businesses must have strict management policies to ensure employees are working properly. 

If the employee's performance is poor, the manager needs to review the process and find ways to support employees to improve their capacity. In addition, managers need to understand the strengths and weaknesses of each person to come up with a plan to help employees maximize their capacity.

Here are ways to help leaders measure employee performance in the company:

  • Define goals: Make sure these are measurable goals. Commonly used criteria for evaluation are KPI and OKR.
  • Monitor work progress: Leaders need to regularly check the progress of their employees, ensuring that all work is completed within the stipulated time.
  • Regularly develop employee evaluations: Enterprises need to organize periodic evaluations to promptly detect problems. From here, management makes plans to reward, motivate or improve the situation.
  • Employee performance improvement plan: The company may regularly organize training sessions to improve the qualifications, skills, and performance of employees.
Employee performance is an important factor to be considered
Employee performance is an important factor to be considered.

Maximize employee skills​

Each employee has unique knowledge, experience, strengths, and weaknesses. The company needs to understand the characteristics of each employee to assign them appropriate tasks. Empowering employees will also motivate them to devote more to their work.

Eliminate manual work​

Studies have shown that eliminating manual work from the process helps businesses improve employee efficiency by up to 30%. The term Paperless Office is being used a lot in business organizations. With this model, the company will gradually shift to using electronic devices and digitizing documents and information in the business.

Eliminating manual work cuts down on hidden costs
Eliminating manual work cuts down on working time.

Apply technology solutions​

Viindoo brings the perfect solution to help cut hidden costs
 Viindoo brings the perfect solution to help cut hidden costs

Applying technology solutions help organizations achieve maximum operational efficiency. From there, the administrator can see the errors and defects in the current process to consider giving appropriate solutions. Moreover, it will be easier to understand employees, thereby building a strong team to accompany and develop. Some advantages of technology applications in business can be mentioned such as

  • Regularly updating the operation status of the processes in the organization, considering the specific reasons why the work is not effective. 
  • Building detailed reports on each employee's performance.
  • Making visual progress reports, and automatically updating data every hour.
  • Providing accurate projections of project completion, and assisting senior leaders in decision-making, response, and appropriate adjustments.

Currently, many companies are applying Viindoo in their business activities. Specifically, this ERP software can help businesses achieve superior efficiency compared to performing management steps manually and traditionally. All information can be shared among employees in the organization to avoid misunderstanding the tasks assigned by superiors. 

Another advantage is that the tightly assembled modular structure will allow companies to refresh and install additional useful features. In addition, businesses can register more users monthly while not affecting the current system.

Outstanding features of Viindoo: 

  • Update project progress and time so that managers can easily track it.
  • Update information about the completion of many different projects.
  • Provide project completion time forecasts based on the actual situation. From here, managers can consider making strategic decisions for the company.
  • Allocate resources reasonably based on the capacity of each employee, optimizing efficiency for the organization.
  • Automatically store all information related to the working process.

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The above article has partly helped readers understand more about the concept, calculation as well as methods to reduce hidden costs. This information will be extremely useful for a business that is in the process of formation and development. Readers can follow the next articles of Viindoo to gain more useful knowledge, which is updated most often.

What are hidden costs? Examples, ways to calculate and cut hidden costs
Viindoo Technology Joint Stock Company, Trần Thị Lâm Anh June 23, 2022