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Profit

From Academic Kids

Profit is defined as the residual value gained from business operations. However, the exact method of calculation differs between accountants and economists.

Profitability refers to the amount of profit received relative to the amount invested, often measured by a rate of profit or rate of return on investment.

Economists and accountants measure profit in slightly different ways, profit will only be the same when all the factors of production have been credited their full opportunity cost.

Economic profit

Economists usually define profits as revenues less the opportunity costs of labor, capital, and materials. Furthermore, profits are divided into two types:

  • Normal profits are the salaries paid to executives in exchange for their entrepreneurial skills.
  • Economic profits are what remain after normal profits are subtracted. It is the economic profit that economists see as the incentive for firms to enter or leave a market.

Some economists define further types of profit:

Economic profit is calculated by <math>\pi\ = (P * Q) - (AVC * Q) - F <math>
where:

Economic profit can also be calculated by <math>\pi\ = (P * Q) - C(Q) <math>
where C(q) is the cost function with respect to quantity.

The derivative of the cost function is the marginal cost, and the value of the cost function with quantity 0 are the total fixed costs.

Accounting profit

In the accounting sense of the term, net profit (before tax) is the residual after deduction of all money costs such as; wages, rent, fuel, raw materials, interest on loans and depreciation. Gross profit is profit before depreciation and interest, Net profit after tax is after the deduction of either corporate tax (for a company) or income tax (for an individual). Operating profit is the net profit with costs/revenue of interest, cost of depreciation, and cost of income taxes backed out.

Another definition of accounting profit is the total revenue minus costs properly chargeable against the goods sold.


TR = Total Revenue

TC = Total Cost

AR = Average Revenue

AC = Average Cost

Q = Quantity demanded/sold


Profit = TR - TC

Profit = (AR * Q) - (AC * Q)

Profit = Q * (AR - AC)


TR = TC results in normal profit.

TR > TC results in supernormal profit.

TR < TC results in losses.

See also

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