Comparison of Accounting Profit vs Economic Profit
Profit is one of the most widely watched financial metrics in evaluating the financial health of a company. Accounting profit and economic profit are having some similarities, but there are few differences between them. In this blog, we are going to discuss Accounting Profit vs Economic Profit.
Accounting profit refers to the Gross revenue minus the explicit costs.
Accounting profit is also known as the net income for a company or the bottom line. It’s the profit after various costs and expenses are subtracted from total revenue or total sales. Those costs include:
- Labor costs, such as wages.
- Inventory needed for production.
- Raw materials.
- Transportation costs.
- Sales and marketing costs.
- Production costs and overhead.
Advantages of Accounting Profit are:
- It is useful in taking some of the important business decisions like investments etc.
- Investors are interested in investing in those businesses which have high accounting profits.
Economic profit is similar to accounting profit in that it deducts explicit costs from revenue. However, economic profit also includes the opportunity costs for taking one action versus another in the period. Economic profit is determined by economic principles, not by accounting principles. Economic profit uses implicit costs, which are typically the costs of a company’s resources. Economic profit is the profit from producing goods and services while factoring in the alternative uses of a company’s resources.
Advantages of Economic Profit are:
- It helps in measuring the efficiency of the firm as it includes how efficiently the resource is allocated.
- Along with accounting profits, economic profits also help in measuring the success factor of companies
Comparison of Accounting Profit Vs Economic Profit
|Comparison Elements||Accounting Profit||Economic Profit|
|Definition||Accounting profit refers to the economic profits earned by the company at the end of the financial year||Economic profits are the profit earned by the company after reducing both the explicit as well as implicit costs from the revenue earned by the organization.|
|Importance||Accounting profits of the company signifies the profitability of the company.||Economic profit signifies how efficiently the company is allocating its resources for earning revenue.|
|Relevance||Accounting profit is relevant for understanding the financial performance of the firm||Economic profits may not provide the correct picture of the financial performance of the firm as it also includes some other aspects like opportunity costs.|
|Numerical Formula||Accounting profits = Revenue – Explicit costs||Economic profits = Revenue – (Explicit + Implicit costs)|