Opportunity cost is about working out the balance of what you are getting vs what you are losing out on
Though revenue is obviously what makes businesses tick, generating income is only part of the picture. Minimising outgoings by keeping operating costs as low as possible is equally as important in maximising working capital and a healthy balance sheet. Therefore, some degree of frugality is necessary for maintaining cash flow for a small to medium enterprise.
One of the major principles of frugality is thus: Don’t pay someone else to do something you can do yourself for free.
Sensible advice on the surface, but the reason many would baulk at the idea of hiring a cleaner, gardener or decorator for their homes is the same reason why many entrepreneurs are bogged down with the day-to-day running of their business, at the expense of actually performing at their best in their core business role.
Is outsourcing really more expensive or risky than keeping your business functions under your control?
In this blog, we will be exploring the microeconomic theory of opportunity cost to hopefully discover the answer.
Opportunity cost is the principle of determining the balance of what you sacrifice vs what you gain when making a choice. It is about recognising that when you say “yes” to something, you are inevitably saying “no” to something else.
Netflix’s popular mindbending interactive film release, Black Mirror: Bandersnatch, encourages us to consider life like a “choose your own adventure” novel by inviting us to interact with the main character in the film and control his decisions. It depicts the effects of these decisions as a series of sometimes insignificant and sometimes glaringly obvious forks in the road, with snaking branches of results, opportunities and consequences trailing from each one.
Black Mirror writer, Charlie Brooker, described the experience of writing the feature as “trying to do a Rubik’s cube in your head” as the tangled web of potential outcomes became extremely complex.
There is no suggestion that, like Bandersnatch’s unfortunate protagonist, we must analyse every decision we make, but rather than that we are more mindful of what we might be missing out on could actually have more value than what we are gaining.
How do you calculate opportunity cost?
There are no agreed formulae to calculate opportunity cost, and that is because there is a mixture of explicit and implied costs, as well as a mixture of hard and soft benefits. Some opportunity costs are financial, and others, like the value of free time and personal wellbeing, cannot be monetised.
The key to evaluating opportunity cost is to think about opportunities in a mathematically logical way, without necessarily applying mathematics to the equation. Think of opportunity costs like a ratio of what you are gaining against what you are losing.
What you gain / (what you sacrifice – what you would pay) = opportunity cost.
Many of our clients were managing their own credit control function prior to taking advantage of our invoicing factoring services for startups and SMEs, so let’s take credit control as an example.
If you spend 4 hours per week doing your own credit control you save yourself “x” amount in outsourcing fees. In those 4 hours, you could achieve something tangible that results in explicit profit, like finding and responding to an invitation to tender for a new contract, which you happen to win. So the opportunity cost of not outsourcing your credit control is, very explicitly, the cost of outsourcing per hour divided by not winning the new contract less the cost of outsourcing. Therefore, in this scenario, choosing not to spend money on outsourcing has a negative impact on your cash flow.
In reality, the formula is unlikely to be as clean and tidy. During those 4 hours, you could attend a networking breakfast and meet a new business partner, client or star employee. You could hold a brainstorming event with your employees and colleagues and solve a major organisational pain point, or discover expansion opportunities. You could play 18 holes of golf.
What you do with the time is your prerogative, and how those activities impact on you and your business is highly variable.
Knowing your strengths and weaknesses, and when to delegate.
With outsourcing, there is also the consideration that hiring expertise may positively impact your success, negating the cost of the initial outlay. There are many business functions that may not be exactly aligned with your particular set of skills, and that’s ok. This is where outsourcing really comes into its own, because not only are you buying back your time, you are also buying someone else’s expertise, skills and experience. You should expect them to yield better results than you.
Knowing how and when to delegate is an important aspect of running your business, whether that is recognising gaps in your knowledge or freeing up your time to best utilise your expertise.
Is invoice factoring outsourcing?
In short, yes. It is outsourcing plus access to a valuable form of alternative finance wrapped up in one package. It is possible to outsource your credit control function without taking funding against your invoices, but we feel the benefits of this financial support is multi-layered and presents even more opportunities for saving time and money.
Recourse factoring provides a funding facility that grows as you grow, it involves the ability to draw a prepayment against your outstanding invoices for a small percentage charge. For this, your factoring company will take over your entire credit control process. So not only do you have access to working capital, but the expertise and professionalism of the credit control process can greatly increase the ability to achieve timely payment.
Last year, research by small business financier Liberis showed that small businesses are spending, on average, 3 days per month chasing outstanding invoices. This equates to £5,000 in man hours and goodness knows how much in terms of missed opportunities – from wasted time to wasted resources that could be spent on other tasks and the wasted potential to invest in growth. We believe that outsourcing is the most efficient and cost-effective way for small to medium enterprises to free up their time and resources for doing what they do best, by buying others time and expertise.
Are there areas of your business where you find yourself wrapped up the in the minutiae, where your time and skills would be put to better use and greater purpose elsewhere? Does our example about credit control eating into your working day ring true? Partnership Invoice Finance can help you unlock working capital and your time with our recourse factoring services for startups and SMEs. We would be happy to talk about your current business and whether we could work together.