When it comes to business decision-making, it’s important to consider various costs and benefits. One of the costs that can often be overlooked is sunk costs.
What are Sunk Costs?
Sunk costs refer to any costs that have already been incurred and cannot be recovered, regardless of the future course of action. In other words, sunk costs are costs that have already been spent and cannot be retrieved. These costs are independent of any future decision and should not influence future decisions.
Examples of Sunk Costs
Some examples of sunk costs include:
- Equipment: Once a company purchases equipment, it becomes a sunk cost since the company cannot retrieve the original investment. Even if the equipment is no longer needed, the company cannot recover the cost of the equipment.
- Advertising: If a company invests in advertising and does not see the expected results, the money spent on the advertising becomes a sunk cost.
- Research and development: If a company invests in research and development for a new product and later decides not to produce it, the money spent on the research and development becomes a sunk cost.
Why are Sunk Costs Important?
Sunk costs are important because they should not be considered when making future business decisions. These costs have already been incurred, and any future decisions should be based on expected future costs and benefits. Failing to account for sunk costs can lead to irrational decision-making and cause a company to continue to invest in projects that are not profitable.