Don’t let “sunk costs” lead to poor decisions

Emotions add zest to life. They propel us to our feet when our favorite running back scores a touchdown. They warm us at an inspirational concert or movie. But in the realm of business, emotions sometimes hinder good choices. In fact, business owners and managers often let emotions dominate the decision-making process.

This is especially true when choices are based on “sunk costs.” Broadly defined, sunk costs are past expenses that are irrelevant to current decisions. For example, many firms hire consultants who sell and install software. In some cases, a company is still waiting –three or four years into the contract term — for a functional and error-free system. Meanwhile, costs continue to escalate. But are those costs relevant? Managers, especially those who initially procured the software and contractor, may reason that pulling the plug on a failed contract would be “wasting all that money we’ve spent.”

Not true. That money is “sunk”; it’s beside the point. Deciding to continue with a non-performing contract instead of staunching the flow of cash and changing course is irrational. It may be difficult to admit that a mistake was made. It may bruise the ego of the decision maker. But abandoning a failed contract is often the wisest decision. The only relevant costs are those that influence the company’s current and future operations.

Let’s say your firm hires a new salesman. You spend thousands of dollars sending him to training seminars. You assign mentors who take time from their busy schedules to provide on-the-job coaching and oversight. But despite your best efforts, the new hire isn’t working out. He doesn’t fit your firm’s culture; he doesn’t grasp the company’s goals and procedures; he doesn’t generate adequate revenues for the business.

As a manager, what should you do? At some point, you may need to terminate that employee and start over with someone else. But what about all that time and money you spent training and mentoring the new salesman? Those costs are irrelevant; they’re “sunk.” You can’t get them back. So the best decision — as of today — may involve cutting your losses and starting anew.

Other examples of sunk costs may be found in the areas of product research, advertising, inventory, equipment, investments, and other types of business expenses. In each of these areas, companies spend money that can’t be recovered, dollars that become irrelevant for current decision making. Throwing good money after bad won’t salvage a poor business investment — or a poor business decision.

About Brenda J. McGivern, CPA

Brenda McGivern started her own certified public accounting and management consulting firm in October 2001. The full service CPA firm provides tax and accounting solutions to meet the needs of today's small business and individual. Brenda McGivern has become a trusted advisor and valuable resource her clients rely on for timely, accurate assistance when they need it. Before starting the firm, she worked as an accountant for three years at a local firm and prior to that five years at a large international CPA firm in Boston. She has performed the following tax services: federal, state and local tax planning, international tax planning, estate and succession planning, mergers and acquisitions, capital retention and IRS representation. She has also coordinated assurance engagements, such as financial statement audits, reviews and compilations from the planning phase through the reporting phase. She has prepared and reviewed regulatory filings for numerous regulatory agencies including the Security and Exchange Commission. Prior to these positions she was selected from over 2,000 candidates into an eight-person intensive financial management program at an international technology company. The program consisted of graduate level classroom study and two six-month rotational assignments in financial operations. She graduated cum laude from the University of Massachusetts at Amherst and holds a Bachelors Degree in Business Administration with a concentration in accounting. McGivern also holds a license in Massachusetts as a Certified Public Accountant and is a member of the American Society of Certified Public Accountants and the Massachusetts Society of Certified Public Accountants. She resides in Stoughton, Massachusetts with her husband Brian, and their sons Sean, Ryan and Conor and their dog, Davis.
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