Profit is one of the crucial and most widely accepted financial metrics that evaluate the financial health of any business. Profit maximization is the ultimate goal of all business enterprises if they want to keep their door open. However, there are certain cases or circumstances where we see a profitable enterprise also getting shut down.
The reason for this can be understood by the people or professionals who know and understand the different measures of profits that are defined to derive short-term as well as long-term viability of the business. Although most profit measures are based on accounting, an alternative calculation is also done to give deeper insights into the business that is valuable and helps to understand the ability of the business to meet its goal.
- Accounting profit is the difference between total revenue and explicit costs.
- Economic profit is the difference between total revenue and total opportunity cost, including explicit and implicit costs.
- Normal profit is the minimum profit required to keep a business running and is equal to the opportunity cost of the resources used in the industry.
Accounting vs Economic vs Normal Profit
The difference between Accounting, Economic and Normal Profit is that accounting profit is income minus explicit cost, and economic profit is income minus explicit and implicit cost. Implicit cost includes the lost opportunity cost and natural resources cost. Average profit occurs for a company when the total revenue equals total cost, which means average profit is the breakeven point.
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|Parameter of Comparison||Accounting Profit||Economic Profit||Normal Profit|
|Definition||It is the actual gains & losses made by the business in a specific year.||It is the supernormal profit, i.e. the difference between the revenues earned and the total expenses paid, including explicit and implicit costs.||The profit considers all explicit and implicit costs while calculating the actual profit and assumes that all costs are paid.|
|Objective||The objective of Accounting profit is to assess the business profitability.||Economic profit aims to understand and assess how well the business is utilizing and allocating the available resources.||Normal profit aims to know whether a firm’s revenue equals the overall business operational costs.|
|Methodology Used for Calculation||Accounting profit is calculated as per the defined accounting principles or GAAP.||The Economic profit is not calculated as per accounting principles rather it is done as per economic principles and considers implicit costs and the foregone opportunity cost.||The Normal profit is assessed by estimating the difference between the cumulative revenue earned and the expenses made.|
|Calculating Formula||AP => Total Revenue – Total Explicit Cost||EP => Total Revenue – (Total Explicit + Total Implicit & Opportunity Cost)||NP => Total Revenue = Total Cost (explicit, implicit, and Opportunity)|
What is Accounting Profit?
Accounting profit can be termed as the actual gains & losses earned by the business in a particular year. It defines the business’s health, whether it is profitable or not.
It is also known as the organisation’s net income after subtracting all possible explicit costs. Explicit costs include administration, rents, production, amortization, taxes, transportation, depreciation paid, etc.
That is directly incurred by the organization to run the business.
Accounting or GAAP principles are specifically defined to calculate the Accounting Profit. In simple words, it is the profit that describes business earnings in favourable terms.
What is Economic Profit?
As we said above, Economic profit is the difference between the generated revenue and the total cost spent to run a business. Total cost includes explicit and implicit costs and foregone opportunities. To understand the Economic cost, one should understand the concept of implicit cost that is directly not incurred by the organizations as cash outlay doesn’t occur.
Thus, it is covered under opportunity cost that describes or provides information about the profit that is foregone because of choosing the alternative. It doesn’t impact the business profitability of the organization because it’s not directly related.
What is Normal Profit?
The business earns an average profit when the difference between the total revenue and total cost subsidized means becomes zero. Expected profit can be considered a breakpoint for the business to sustain itself in a competitive market.
If anything exceeds the average profit, the organization will start incurring losses. Thus, to remain operational or sustain revenue must equal the cost of production.
Main Differences Between Accounting, Economic and Normal Profit
To remain competitive in the market and taste business success, an organization must derive profits; otherwise, there is no point in running the business operations by putting money from one’s own pocket.
To realize the actual profit, financial analysts and economists have made the concept of Accounting, Economics, and Normal profit to assess the correct picture of the business or organization’s status. All three concepts are related to profit but with slight variations in understanding and calculation methodology.
- Accounting profit tells what is happening in the business regarding gains & losses, considering only explicit costs. And economic profit tells what all has gone considering explicit and implicit costs, including the foregone opportunity cost. Expected profit is the cut-off point where business profit equals the expense paid.
- Accounting profit is calculated per the accounting or GAAP principles, whereas an Economic profit is calculated per economic principles. And average profit is assessed as per the business situation.
- Accounting profit is used to check the business’s health and profitability, whereas Economic profit tells how well the organization is utilizing or allocating its available resources. The Normal profit tells whether businesses can sustain or are collecting the required revenue or not that is required to pay the explicit and implicit costs for running the business operations.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.