Of course calculation in business is not something new as it revolves round her world. Calculating economic profit of a business is one of the numerous calculations business owners are faced with. This post will throw some light into the title, giving an overview of it, for a perfect clarification.
Economic profit is the difference between the total revenue received by a businesses and the total implicit and explicit cost of the firm. Economic profit is often the extra profit left over after considering the next best alternative investment and can be either positive or negative in value.
In most cases, people tend to confuse economic profit with accounting profit, which is a firm’s revenue minus its explicit costs. And the explicit cost of a firm is what most people in the business world think of as regular business expenses. But they are rather the actual payments made to others (business partners and clients) for running a business, such as paying rents, wages, utilities and purchasing various equipment like that of I.T equipment.
The major difference between the economic profit and accounting profit is that it includes all implicit costs. These implicit costs, are opportunity costs equal to what a business firm or individual gave up in order to do something else, probably that necessary. As usual, these costs are not left or ignored, as they are deducted from revenues and are the alternative returns one decided not to pursue.
Basically, adding implicit costs to profit calculation, gives one a better hand and another way to compare financial alternative. For this reason, it is virtually possible to have a positive accounting profit and a negative economic profit for a business.
A negative profit simply implies that one could be financially better off by engaging in a different opportunity. On the other hand, a positive economic profit implies that there is no available or comparable opportunities that are practically profitable because they are already factored in the calculation.
Formulas for calculating Economic Profits+
- Account Profit = Total Revenues – Explicit Cost
- Economic Profit = Accounting Profit – Implicit Costs
- Economic Profit = Total Revenues – (Explicit Costs + Implicit Costs)