When you wake up in the morning, you may not realize financial concepts are already at play. If you wake up late, you may have to decide to skip the coffee line and head straight to your client meeting. Skipping the line for a quick pick-me-up drink to speak with your important client is an example of opportunity cost. Every time you choose between two things that could be good or best, you give up one choice in favor of a higher potential reward.
Financial Concepts: Opportunity Cost
Professional investor Jason Fernando defines the financial concept of opportunity cost as “the potential benefits that an individual, investor, or business misses out when choosing one alternative over another.” (See investopedia.com) In other words, when you have to pick between two things, sometimes you might miss out on good things that the thing you didn’t pick could have given you. However, you should remember how a good thing now can be given up in exchange for a long-time reward.
Financial Concepts: Return on Investment
Taking your new basic understanding in hand, I would say there is a strong correlation between the financial concepts of opportunity cost and return on investment. Return on investment is like staying an extra hour for a few weeks at work so you could enjoy a party and celebrate your accomplishment. Peter Carleton from Investing Answers Inc. states that return on investment is “a key financial ratio that measures the gain/loss from an investment about the initial investment.” (See investinganswers.com) That is to say, money towards real estate instead of fancy company lunches every month may prove to yield a higher return on investment. The opportunity cost is whether you want to invest time back into your employees or put it forward toward your next acquisition.
Financial Concepts: Real-World Example
Now I would say it’s fair and well to go about doing business after already understanding these financial concepts, but what if you still don’t know how these two principles work