What Is an Economic Profit?

Economic profit refers to the difference between the profit of a manufacturer and its cost. The latter includes the benefits that can be obtained from the use of the resources of another manufacturer, which is the most advantageous.

Economic profit

Pros and cons of economic profit

The main advantage of economic profit is that it is more explanatory than accounting profit. That is, the net asset (or capital) is the amount of corporate wealth stored at a certain moment, and the profit is the amount that flows out of the wealth in a certain period. Only outflows that exceed storage can be considered profit. The determination of economic profits requires the valuation of all or specific assets and liabilities at the beginning and end of each period. Because it cannot provide sufficient information about a company's specific operating activities, the concept of economic profit is rarely used in accounting practice, and the concept of accounting profit is generally used.

Economic profit characteristics

The possibility and rationality of economic profits;

Economic profit is a necessary compensation for the risks assumed by the manufacturer's investment;

Profits above normal are a reward for successful innovation;

Above-normal profits are special skills that result from good management;

Individual manufacturers in certain industries will earn higher-than-normal returns for a certain period of time because they effectively dominate the market;

There is a long-term equilibrium normal profit rate that all manufacturers can earn; however, at any one point in time, each manufacturer in a particular industry may earn more or less than this normal level.

Economic profit calculation

Economic profit The difficulty of economic profit calculation lies in the measurement of net assets at the beginning and end of the period. There are the following methods of pricing:

1. The capitalized value of the future cash flows expected to be received by the enterprise during its existence;

2. The total sale price of various assets of the enterprise minus the total amount of various liabilities;

3. The number of shares issued by the company multiplied by the stock market price determined on the exchange market;

4. The input value of the company's non-monetary assets (original cost or current cost), plus the cash present value of the monetary assets, minus liabilities. Each of the above methods has its rationality and feasibility, but at the same time, it is also accompanied by corresponding defects. Due to the different methods of measuring the net assets at the beginning and end of the period, the amounts of economic profits are also different.

Economic income is different from accounting income

Economic income refers to the maximum expenditure in a certain period when the end of the period and the beginning of the period are equally rich. Income here is measured under the property law. That is: current income = property at the end of the period-property at the beginning of the period.

Example: An enterprise's assets at the beginning of the year are 100,000 yuan, and the year-end appreciation is 120,000 yuan. In this year, the operating income is 50,000 yuan, and the economic income is 70,000 yuan. Calculate income. The reason is: it was not achieved through sales, and it lacked objective income evidence. Therefore, many enterprises take advantage of this shortcoming of accounting, and can change the practice of income through false transactions to achieve the purpose of controlling profits.

Economic profit difference

The difference between corporate accounting profit and economic profit

The differences between economic profits and accounting profits are mainly reflected in the following points:

1. Service subjects are different.

2. The purpose angle is different. Accounting profit is an indicator of operating results from the perspective of the owner of the enterprise, and economic profit is from the perspective of the company. The company is a relatively independent subject. Capital can be raised through two channels: debt capital and equity capital. For the company, both creditors and shareholders are "investors". When the company calculates that it has economic profits, it means that investing in this company will obtain " "Excess profits" will naturally attract more funds into the company.

3. The range of measurement is different.

4. Different measurement basis.

5. Cost measurement is different.

6. Different applications.

7. The measurement procedures are different.

8. The basis for evaluating the economic benefits of enterprises is different.

Economic profit is the concept of profit held by economists. Although the profit of an economist is also the difference between income and cost, economists have a strict definition of profit. For accountants: profit = total revenue-total cost, but for economists, this result overestimates profit. The reason is that economic income is different from accounting income, and economic cost is different from accounting cost. Therefore, economic profit is different from accounting profit.

Economic costs include not only the costs actually paid in accounting, but also opportunity costs, that is, the compensation that companies must pay to resource providers in order to attract resources from other production opportunities. These rewards can be explicit or implicit. We call monetary payments made by companies to non-business owners who provide resources for them as explicit costs, and the costs of using resources owned by the enterprise as hidden costs.

Both external resources (such as debt capital) and own resources (such as shareholder capital) have costs. The return of shareholders' investment in capital is no less than the interest of creditors and the wage requirements of employees. For businesses, hidden costs are the profits that can be made by using the resources you have for other best uses. Accountants do not recognize hidden costs and do not include them in the income statement. The reason is: there is no objective way to calculate hidden costs, and accountants are unwilling to make unfounded estimates.

For example: Wang is the sales manager of a company, with an annual salary of 80,000 yuan, and the bank can earn interest of 5,000 yuan. I have decided to open a department store and use one of my storefronts as the business space for the supermarket. The original storefront rental income is 30,000 yuan, and 5 employees are required. After one year of operation, the accounts are as follows: Cost: 60,000 yuan; Employee's salary: 30,000 yuan; Miscellaneous electricity: 10,000 yuan; Total (explicit) cost: 100,000 yuan; Accounting profit: 150,000 yuan.

However, this accounting profit cannot accurately show the economic status of the company, because it ignores the hidden costs: Wang provided financial capital, stores and labor, and hidden costs (abandoned income) occurred, then economic profits: accounting profits: 150,000 yuan; abandoned salary income: 80,000 yuan; abandoned interest income: 50 thousand yuan; abandoned rental income: 30,000 yuan; total hidden cost: 115,000 yuan; economic profit: 35,000 yuan.

Economists and accountants have different concepts of "profit", accounting profit = total revenue-explicit cost, economic profit = accounting profit-hidden cost = total revenue-opportunity cost of all inputs.

If the total revenue of an enterprise exceeds the entire economic cost, the remainder is owned by the enterprise, and this surplus is called economic profit or net profit. The difference between accounting profit and economic profit should also be considered: the accounting measurement basis is inconsistent, the calculation of accounting profit is based on accrual basis, and the calculation of economic profit is based on accrual basis and cash realization (cash flow method) Organically combined and unified. Modern enterprises establish a financial management system with value management as the core. The economic profit method has become an increasingly popular financial management idea. Its tempting point is that taking economic profit as the corporate goal can promote the value creation concept Going up and down the enterprise is in line with corporate shareholders and creditors demanding higher returns than the cost of capital, thereby helping to maximize corporate value and shareholder wealth.