Accounting profit, also referred to as financial profit or bookkeeping profit, is a company’s net income, or total revenue minus explicit costs. Accounting profit is used to assess a company’s performance and compare its financial position to competitors.
Another term you might come across when researching accounting profit is economic profit. Economic profit is a company’s net income minus explicit and opportunity costs. The purpose of calculating economic profit is to help businesses make sound financial decisions about the kinds of opportunities they want to invest in.
Explore the similarities and differences between these two concepts in the terms and table below:
Explicit costs: refer to the trackable, quantifiable costs of raw materials, employee wages, and other expenses
Implicit costs: refer to a type of opportunity cost and relate to ideas or decisions, rather than physical items, such as when a company makes a decision that reduces its potential income. For example, when hiring a new employee, there is the explicit cost of paying wages, as well as an implicit cost of the time it takes a hiring manager or leader to interview and onboard the employee.
Opportunity costs: represent the potential benefits that a company foregoes when choosing one option over its alternatives. An example of an opportunity cost could be choosing to invest in expensive equipment over cheaper alternatives, if the perceived value and benefits of the expensive equipment are higher.
Cost of goods sold (COGS): refers to the cost of producing goods or services. COGS can include materials, labor, software, distribution, etc.
Economic principles: common theories on what influences economic and market activity
Generally accepted accounting principles (GAAP): refers to guidelines that keep accounting practices consistent and comprehensible across industries, individual companies, and spans of time
|Accounting profit||Economic profit|
|Calculates only explicit costs||Calculates explicit costs, implicit costs, and opportunity costs|
|= Total revenue - explicit costs||= Total revenue - (explicit + opportunity costs)|
|Based on generally accepted accounting principles||Based on economic principles and market activity|
|Factors in only actual, concrete financials||Factors in assumptions and estimates|
|Reported to the IRS||Not reported to the IRS|
Now that you have a clear accounting profit definition, the next step is to understand why it’s important. Profit is a crucial metric for measuring the health and performance of a company. If your company is profitable, it may stand a greater chance of surviving in the long term.
Knowing your company’s accounting profit can make it easier to plan for its financial future. For example, if one of your products has a low product margin, meaning that the selling price for one unit isn’t much higher than the cost of producing it, then you might consider reducing costs or raising the price.
In addition, knowing your accounting profit is useful for measuring your company’s performance against your competitors so that you have an idea of where you stand in your niche.
Calculating accounting profit is a fairly simple process and should be a regular part of your business strategy. You may find it useful to keep track of earnings and costs on a spreadsheet or with accounting software.
Use the steps below as a guide to calculate accounting profit.
Select a time period to measure your company’s total earnings such as monthly, quarterly, or yearly. Add up the income from every revenue stream.
Account for all of your explicit costs—everything that is an expense related to operating your business—and come up with a total. Explicit costs might include:
Physical equipment or supplies
Contractor and employee compensation
Facility or building rental
Commercial real estate mortgage
Professional membership fees
Once you have figures for both the total revenue and explicit costs, simply subtract costs from revenue, and you’ll know your accounting profit.
Refer to this accounting profit formula on a regular basis to know where your business stands: accounting profit = total revenue - explicit costs
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