Economic Profit

Economic profit is actually the number which indicates the profit made by the firm after carrying out various business transactions. When we calculate economic cost with the help of the formula, we deduct the opportunity costs from the total revenues. The calculation can help us draw many conclusions regarding the functioning of our business. In the next section, we explain this concept in detail and also help you learn calculate the same.

Importance of Calculating Economic Profit

The calculation of economic is very essential to know whether the business we are doing is profitable enough or not. High economic profits indicate effective cost control techniques implemented by the management of the company. On the other hand, economic profit would be low for those businesses where expenses made by the company are relatively high and the sales growth is not up to the expectations. The calculation is done by subtracting the total expenses and opportunity lost cost from the total income.

From the calculation, we can come up with some ideas to improve our overall performance. This number can help us understand where we are lacking and what measures can help us overcome these issues. A zero profit may be observed in case of start up firms where the interest outgo is very large and there is lack of consistency in revenues. In the calculation, the expenses which are taken into consideration can be administrative costs, employee salary costs, cost of goods and materials, income tax paid, legal counsel expenses, interest payments, depreciation etc. Almost all firms have qualified financial experts, tax consultants, and auditors to calculate their economic profit. What we all should understand here is that economic profit is a concept related to management accounting which involves keeping a record of all sales, expenses and operating costs for the benefit and reference of the company.

Economic Profit = Total Income - Total Expenses - Opportunity Lost Cost

There is a difference in the concepts of economic profit and accounting profits. It has been observed that many people are not aware of this difference and they end up getting confused about this whole thing.

Difference Between Economic Profit and Accounting Profit

Accounting profit is the excess of business income over the business expenses. Suppose that a company manufactures products by spending USD 5 and makes 5,000 products. The price at which the company sells the products is USD 6. Then the accounting profit here would be (6*5000)-(5*5000)= USD 5000. If the company is unable to sell its products above its manufacturing price, then it will be making an accounting loss. The difference between accounting and economic profit is that accounting profits do not include the implicit costs which the company has to incur. Given below is the formula for accounting profit:

Accounting Profit = Total Income - Total Expenses

Use the above information to make your balance sheet stronger by making the right decisions.