Professional Documents
Culture Documents
1 Business Vs Economic Profit: Table of Contents
1 Business Vs Economic Profit: Table of Contents
Table of contents:
2
Business vs Economic profit
Profit………………………………………………………………….……………3
Business profit……………………………………………………………......3
Explicit cost……………………………………………………………….…..…3
Formula…………………………………………………………………………….3
Example…………………………………………………………………………...4
Economic profit…………………………………………………………..……4
Opportunity cost……………………………………………………….……..4
Implicit cost………………………………………………………………….…..4
Formula………………………………………………………………………….…5
Example…………………………………………………………………………….6
Conclusion……………………………………………………………….…….….8
References ………………………………………………………………………..8
3
Business vs Economic profit
What is Profit?
“Profit simply means a positive gain generated from business operations or
investment after subtracting all expenses or costs”.
Formula:
Profit = Total revenue - Total cost
Formula:
Here’s how we can write the formula of calculating the accounting profit:
Accounting profit = total revenue – Explicit costs
Explicit cost:
“Explicit Costs are the costs which involve an immediate outlay of cash from the
business.’’
The cost is incurred when any production process is going on, or activity is conducted
in the normal course of business. The cost is a charge for the use of factors of production like
land, labor, capital and so on. They are in the form of rent, salary, material, wages, and other
expenses like electricity, stationery, postage, etc. It is also called as Out of the Pocket Cost.
“It is defined as the minimum return necessary to attract and retain the investment “
Normal rate of return is important because business profit can be converted into more
profit if you have some profit left.
Example:
Accounting profit is explained by taking a simple example. Let us suppose, the total
revenue of a furniture shop from the sale of furniture in 2019 is Rs 500,000. Its costs on the
purchase of raw material is Rs 150,000, payment of wages and other utilities is Rs 200,000.
Calculate accounting profit of the company for the year 2019 based on the given information.
Solution:
First Explicit Costs is calculated using the formula given below:
4
Business vs Economic profit
Explicit Costs = Cost of raw material + Payment of wages and other utilities
Explicit Costs = 150,000 + 200,000
Explicit Costs = 350,000
Economic Profit:
Before discussing the definition of economic profit, we have to understand the
concept of implicit cost and opportunity cost.
Opportunity cost is the loss of other alternatives when one alternative is chosen.
Opportunity lost is opportunity cost.
For example: At the ice cream shop, you have to choose between rocky road and
strawberry. When you choose rocky road, the opportunity cost is the enjoyment of the
strawberry.
Implicit cost does not involve a cash transaction, and so we use the opportunity cost
concept to measure them. Implicit costs are related to forgone benefits of any single
transaction. These are intangible costs that are not easily accounted for.
Example, the time and effort that an owner puts into the maintenance of the company rather
than working on expansion.
So, the
Economic profit is the difference between the total revenue received by a business
and the total implicit and explicit costs of a firm.
Economic profit is similar to accounting profit in that it deducts explicit costs from
revenue.
5
Business vs Economic profit
Formulas:
Here's how you can write the formulas for calculating economic profit:
Example:
• Ali started a restaurant business on his own land. In the first year, he has made
revenue of Rs.550,000. Since he is new in this business, so he has to buy a new
food equipment and food and also, he has to hire the employee to run the
restaurant. He made a scribbled note which looks as follows –
• Wages paid to employees – Rs.100,000
• Food items – Rs.200,000
• Equipment – Rs.50,000
• Using the information above, you need to find out the accounting profit of Ali in
the first year of his restaurant business. And also calculate economic profit (or
loss) due to his decision to start this business.
• From the information mentioned above, first, let’s find out the accounting profit
–
• Accounting Profit = Total Revenue – Explicit Costs
• So, we know the total revenue here, i.e. Rs.550,000.
• We need to compute the explicit costs –
Ali can earn Rs.250,000 by rented his place. We assume that if he would have not
started his business in this year, he could have earned Rs.250,000 by rent. That means
Rs.250,000 is his opportunity cost for starting off with this business.
Here’s the formula:
Practical:
Business profit is more practical as it is based on what has actually happened
throughout the year or quarter.
Economic profit, however, is based on the assumptions and reflects the decisions that
a company could have taken.
Relevance in Short term and long Term:
8
Business vs Economic profit