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 but having said that, there are certain cases or circumstances where we see a profitable enterprise is 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 the long-term viability of the business.
Although most profit measures are based on accounting but the 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 vs Economic vs Normal Profit
The difference between Accounting, Economic and Normal Profit is that accounting profit is income minus explicit cost, economic profit is income minus explicit and implicit cost. Implicit cost includes the lost opportunity cost and natural resources cost. Normal profit occurs for a company when the total revenue is equal to total cost which means normal profit is the breakeven point.
Comparison Table Between Accounting, Economic and Normal Profit
|Parameter of Comparison||Accounting Profit||Economic Profit||Normal Profit|
|Definition||It is the actual gains & losses made by the business in the specific or particular year.||It is the super normal profit i.e. the difference between the revenues earned and the total expenses paid including explicit as well as implicit cost.||It is the profit that 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.||The objective of Economic profit is to understand and assess how well the business is utilizing and allocating the available resources.||The objective of Normal profit is to know whether a firm’s revenue is equal to the overall business operational costs or not.|
|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 health of the business whether it is profitable or not. It is also known as a net income of the organization after subtracting all possible explicit costs.
Explicit costs include administration, rents, production, amortization, taxes, transportation, depreciation paid, etc. that are 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 positive terms.
What is Economic Profit?
As we said above, Economic profit is the difference between the generated revenue and total cost spent to run business, where total cost includes explicit as well as implicit cost along with foregone opportunity.
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 take place.
Thus, it 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?
Normal profit is earned by the business when the difference between the total revenue and total cost subsidized means become zero. Normal profit can be viewed as a breakpoint for the business to sustain in a competitive market.
If anything goes below normal profit then 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 organization must derive profits, else there is no point of running the business operations by putting money from own pocket.
To realize the actual profit, financial analysts and economists have made the concept of Accounting, Economic, and Normal profit, so that the correct picture of the business or organization status can be assessed. All three concepts are related to profit but with little variation in understanding and calculation methodology.
- Accounting profit tells what is happening in the business in terms of gains & losses considering only explicit costs. And economic profit tells what all has gone considering explicit and implicit costs including the foregone opportunity cost as well. Normal profit is the business cut-off point where business profit equals the expense paid.
- Accounting profit is calculated as per the accounting or GAAP principles whereas an Economic profit is calculated as per economic principles. And normal profit is assessed as per the business situation.
- The Accounting profit is used to check the business health and profitability whereas Economic profit tells how well the organization is utilizing or allocating their available resources. The Normal profit tells whether business can sustain or are they collecting the required revenue or not that is required to pay the explicit and implicit costs for running the business operations.
Frequently Asked Questions (FAQ) About Accounting, Economic and Normal Profit
What does it mean when a company makes zero economic profit?
A company making zero economic profit means that it is in the state of normal profit. In this state of profit, almost all of the resources have been used efficiently.
Normal profit includes both explicit and implicit costs. It occurs whenever the difference between the total revenue of a company and the combined explicit and implicit costs amounts to zero.
What is the difference between normal and supernormal profit?
Normal profit is the minimum amount of money a company has to make in order to remain in business. Whereas the profits earned exceeding the normal profit which constitutes a part of the cost of production is called supernormal or abnormal profit.
A spike can be seen in this kind of profit because of the monopoly.
What is the normal profit and abnormal profit?
Normal profit is when the total costs become equal to the total revenue of that particular company. Such a profit states why a company is still up and running in the market. It is also included in the costs of production. To put it simply, normal profit is the amount a firm or organization requires to remain in business.
Normal profit just shows if the resources are used efficiently. Profits exceeding the normal profit are known as abnormal profit or supernormal profit or excess profit.
Abnormal profits are great when it comes to making a profit in a short span of time.
What do you mean by normal profit and super profit?
When a company makes sufficient money that they can cover its total costs while remaining in business, then it is making normal profits. The economic profit is considered zero when an organization is making a normal profit. It is also called zero economic profit.
Any profit which is made in excess of normal profit is considered to be the super profit.
What is an example of economic profit?
In simple terms, economic profit implies that you are making more profit in your current job or business than the earlier one.
For example, you started a bakery after leaving your job as a consultant where you were making $50,000 a year. Your bakery reaps a profit of $75,000 a year.
In this case, economic profit would be
$75000 – $50000 = $25000
You have made $25,000 more than you used to make as a consultant.
Understanding the business profits concepts is very critical and vital as it helps to decide the present and future of the business.
It also outlays the path of business success and helps to assess & make informed business decisions.