Economic Profit

 

 Economic Profit

 

Generally,when we hear the word “profit”we directly remember the accounting profit.Accounting Profit is found out by finding the difference between the revenue earn during a certain period and  total costs associated with the product. Economic Profit is the  between the  the total revenue generated by a business and the total implicit and explicit costs associated with that particular business to a firm. Economic profit is generally confused from the accounting profit.

While calculating accounting profits only explicit costs are subtracted from the revenue while calculating the profit a company has made.Explicit cost can be thought of as what most people think of as regular business expenses paid to others for running a business.Economic profit differs from accounting profit because it also includes implicit costs which are the opportunity costs equal to what a business or individual gave up in order to do something else to that particular job or business.These costs are deducted from revenues and are the alternative income or revenue sources you decided not to pursue. Including implicit costs to your profit calculation gives  another way to compare financial alternatives known as economic profit.

There is a possibility that a business has a positive accounting profit and a negative economic profit for a business. A negative economic profit implies that you could be financially better off by engaging in a different opportunity that in fact you chose not to do. A positive economic profit implies that therewhere no other  opportunities that were  more financially profitable.

For example ,Rajeev had two different business opportunities either to open up a restaurant or to work as a employee of a company.The initial investment along other costs sums up to be  INR 1,00,000 for both of them. Rajeev chose a restaurant and was able to earn a revenue of  INR 1,65,000 ,making a sweet profit of  INR 65,000 .Rajeev was quite happy to have earned the profit. Rajeev  had been quite foolish to leave his job as he earned a sum of  INR 90,000 in a year.In terms of accounting profit he has a profit or  INR 65,000  but his economic profit is a negative  INR 30,000 .The negative economic profit doesnt say that a company or business or an individual is in a loss but it tells that he could earn more if he were to take up another opportunity available to him.

[highlight]Actually it tells if it is even sensible to run a business comparing with other opportunities.It also helps you decide if you are making the right decision by  not taking up a particular opportunity or by choosing to take up a particular opportunity.It also provides a platform to compare different opportunities based on the money value associated.Money isn’t everything and shouldn’t be the only basis to compare the opportunity,one’s willingness,enthusiasm,feelings and goal also are among the crucial factors.

 

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