What are sunk costs?

Sunk costs refer to expenses that have already been incurred and cannot be recovered. This concept is critical in business decision-making because it highlights the importance of not allowing past investments to influence current or future decisions. When evaluating options for a project or business decision, it's important to focus on future costs and benefits rather than past expenditures that will not change regardless of the outcome. Recognizing sunk costs helps avoid the "sunk cost fallacy," where individuals or businesses feel compelled to continue an endeavor because they have already invested heavily in it, rather than making decisions based on current circumstances or potential future returns.

Understanding sunk costs can lead to more rational decision-making, as it encourages stakeholders to consider only the incremental costs and benefits of future options rather than emotional attachments to prior investments.