Regretting what you didn’t do?: The cost of the opportunity lost

振り返る (Furikaeru) – Looking back

When you seat down and look back in your life there are always events that could have happened in a complete different way should you have chosen differently. What if I had studied medicine instead of engineering? What if I had traveled more instead of settling down? What if I had taken the job in that uncertain startup instead of taking the more secure job? The list goes on and on as every day, from the very moment we wake up, we are making decisions.

Decisions, decisions, decisions… when you ask someone more veteran and wiser (than not older ☺) they all say the same: they regret what they didn’t do, not what they did. What is done is done and you are now enjoying the benefits of that decision, but you will never know how things could have developed otherwise. Even so, life still goes on and we are happy with it. You can not keep living thinking that your life would be different if you had chosen something else.

Understanding the logic behind the decision makers

But this is not the case with companies. Companies need to make decisions trying to anticipate what may happen, calculating whether the decision they are going to make is the wiser of the possible options…and always from a financial perspective, controlling the risk that may be involved at all times. Think that a company is there to make money. We, all of us, are part of the engine that moves the business and, as such, we are part of an excel sheet whether we like it or not. We will be fine as far as the cell where we stand stays in black…not sooner it becomes red than our CV will need to be updated.

I will make it simple to everybody: Lost opportunity costs is the actual money you lose due to a financial decision you make verses a different financial decision. The money you lose must be an actual cost and not hypothetical. However, there is a part where I don’t fully agree with the “financial gurus”. Many claim that the cost of lost opportunity cannot be calculated between two investments you have not made. I think you should make every possible calculation and risk assessment before you commit your money. I’ll give you an example that will make things a lot clearer.

Let’s say that you have $50.000 to invest and given the opportunity to invest in two different start-ups:

Startup 1: $50,000 earning 10% for 4 years = $73,205 final return.

Startup 2: $50,000 earning 20% for 4 years = $103,680 final return.

It is a no-brainer to say that we would invest in the startup 2 as it will double our investment. Let’s say now that there is a clause by which the startup 1 warranties us the 10%. However, startup 2 mentions that due to the world economy and the sort of products they mean to develop the interest is not warrantied and, worst case scenario, we will obtain a 5 % gain, with an end balance of $60,775.

Would it be worth the risk? It depends. In the worst of the scenarios you just earn some money and don’t lose anything. If everything goes fine you double your investment. Let’s mention that this is just an example as, most of the time, the real risk is to lose all your money should the start-up not work and make the break through as expected. Not everybody is Facebook, Apple or Amazon…

Is this how capital risk investment companies work? Not entirely. They will surely diversify the investment in between the two companies, and depending on the risk that the final customer may want to accept will invest more heavily in one or the other. The more risk the customer is willing to assume the more money will be “given” to the second company.

The misconception of mixing “opportunity cost” with “opportunity lost”

When you are starting a business there are a number of concepts that people should keep in mind, most of them pure common-sense applied…the least common of the senses.

If you are about to open a new business you will need money to make it run. It would be totally unacceptable if you thought that not sooner your business starts working you will have money generated and a source of cash flow at your disposal. To make money you have to spend money, and money can be very expensive.

Just for the sake of it, lets imagine that we are about to open a new company servicing cars. We charge our clients $100 per hour and we will open 8 hours per day 20 days per month, serving two customers at the time. We will (potentially) make $32.000 per month. However, to service the cars we need operators and specialized equipment costing $60 per hour. This means that the opportunity cost is of $19.200, being our theoretical benefit of $12.800; and I say theoretical as there will be expenses to further deduct such as insurance, rental, bills, etc. Thus, the opportunity cost is something that the company will try to reduce to the maximum to maximise benefits. Normally you would compute your opportunity cost as your OPEX (Operating Expense) or recurring costs in order to keep your company working.

Calculating the “Opportunity Cost”: Is it worth it?

There are occasions in which multiple investments are not possible so you have to make the decision on what to do. In finance there is a straight forward formula that simply tells us what the difference is in between the investments if we were ahead:

Opportunity Cost = Return of Most Lucrative Option – Return of Chosen Option

Let’s imagine that after running our company for some time we have money to spend. We could either invest in different funds, high risk stock market or stock options, giving us a 15% return. However, should we invest that money into our own company (new equipment and technology) it would give us a 12% return. The opportunity cost would be that 15% minus 12%, resulting on a 3%. Is that 3% worth it? It depends since it may be very expensive. Investing externally instead of investing in your own company may give the wrong signals to shareholders as they will expect the company to work more and better…and what message would be sent to the market if you dont trust in your own company to invest?

 

Whatever you do in your company, as in your life, should be done in consciousness and don’t look back once you have chosen. Live to the full by your decision and, worse comes to worst, think that when a door closes a window opens.

Having said that…

“Nothing is more expensive than a missed opportunity”

H. Jackson Brown Jr.

 

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