Profit

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For the television series, see Profit (TV series)

Profit, from Latin meaning "to make progress", is defined in two different ways. (Pure) economic profit is a positive return made on an investment by an individual or by business operations after all costs, including a normal return to capital and returns to risk, are accounted for. Accounting profit is the difference between retail sales price and the costs of manufacture. Accounting profit will be positive even in competitive equilibrium when pure economic profits are zero.

Accounting profits can include economic rents. For instance, a monopoly can have very high economics profits, and those profits might include a rent on some natural resource that firm owns, where that resource cannot be easily duplicated by other firms.

1 Economic definitions of profit
2 Accounting definitions of profit
3 More varieties of profit
4 See also
5 External links

[edit] Economic definitions of profit

Note: these definitions are different from those used by accountants

In economics, a firm is said to be making an economic profit when its revenue exceeds the total (opportunity) cost of its inputs. It is said to be making an accounting profit if its revenues exceed the accounting cost the firm pays for those inputs.

In a single-goods case, a positive economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average cost and the price.

(In circumstances of perfect competition, average cost = marginal cost at the profit-maximizing position)

All enterprises can be stated in financial capital of the owners of the enterprise. The economic profit may include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise will succeed or not. In these cases, economists treat returns to risk as part of the profit, as it is also an element of the cost of capital.

Economic profit does not occur in perfect competition in long run equilibrium. Once risk is accounted for, long-lasting economic profit is thus viewed as an inefficiency caused by monopolies or some form of market failure.

Positive economic profit is sometimes referred to as supernormal profit.

The social profit from a firm's activities is the normal profit plus or minus any externalities that occur in its activity. A polluting oil monopoly may report huge profits, but be doing relatively little for the economy and damaging the environment. It would exhibit high economic profit but low social profit.

[edit] Accounting definitions of profit

Note: these definitions are different from those used by economists

In the accounting sense of the term, net profit (before tax) is the sales of the firm less costs like as wages, rent, fuel, raw materials, interest on loans and depreciation. Within US business, the preferred term for profit tends to be the more ambiguous income.

Gross profit is profit before Selling, General and Administrative costs (SG&A), like depreciation and interest; it is the Sales less direct Cost of Goods (or services) Sold (COGS),

Net profit after tax is after the deduction of either corporate tax (for a company) or income tax (for an individual).

Operating profit is a measure of a company's earning power from ongoing operations, equal to earnings before the deduction of interest payments and income taxes.

To accountants, economic profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is the net profit after tax less the equity charge, a risk-weighted cost of capital. This is almost identical to the economist's definition of economic profit.

Some economists define further types of profit:

Abnormal (or supernormal profit)
Subnormal profit
monopoly profit (super profit)

Optimum Profit - This is the "right amount" of profit a business can achieve. In business, this figure takes account of marketing strategy, market position, and other methods of increasing returns above the competitive rate.

[edit] More varieties of profit

There are commentators who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as EVA or Economic Value Added.