How to Calculate Accounting Profit and Economic Profit

Understanding the difference between accounting profit and economic profit is crucial for business decision-making. Accounting profit is the net income reported on financial statements, while economic profit considers the opportunity cost of capital. This guide explains how to calculate both types of profit, their implications, and how they differ.

What Are Accounting Profit and Economic Profit?

Accounting profit and economic profit are two fundamental concepts in economics and accounting that measure the success of a business. While they are related, they differ in their calculation and interpretation.

Accounting Profit

Accounting profit is the net income reported on a company's income statement. It is calculated as total revenue minus total expenses, including both explicit costs (such as wages and materials) and implicit costs (such as the opportunity cost of capital).

Economic Profit

Economic profit is the difference between total revenue and the total cost of production, including both explicit and implicit costs. It represents the actual profit that owners of the business receive after accounting for the opportunity cost of capital.

Key Difference: Accounting profit is the net income reported on financial statements, while economic profit considers the opportunity cost of capital.

How to Calculate Accounting Profit

Accounting profit is calculated by subtracting total expenses from total revenue. The formula is straightforward but includes both explicit and implicit costs.

Accounting Profit = Total Revenue - Total Expenses

Steps to Calculate Accounting Profit

Calculate total revenue from all sources.
Calculate total expenses, including both explicit and implicit costs.
Subtract total expenses from total revenue to get accounting profit.

Example Calculation

Suppose a company has total revenue of $100,000 and total expenses of $70,000. The accounting profit would be:

Accounting Profit = $100,000 - $70,000 = $30,000

This means the company has an accounting profit of $30,000.

How to Calculate Economic Profit

Economic profit is calculated by subtracting the total cost of production from total revenue. This includes both explicit and implicit costs, such as the opportunity cost of capital.

Economic Profit = Total Revenue - Total Cost of Production

Steps to Calculate Economic Profit

Calculate total revenue from all sources.
Calculate the total cost of production, including explicit and implicit costs.
Subtract the total cost of production from total revenue to get economic profit.

Example Calculation

Using the same company with total revenue of $100,000, but with a total cost of production of $80,000 (including the opportunity cost of capital), the economic profit would be:

Economic Profit = $100,000 - $80,000 = $20,000

This means the company has an economic profit of $20,000.

Comparison Table

Aspect	Accounting Profit	Economic Profit
Definition	Net income reported on financial statements	Profit after accounting for opportunity cost of capital
Calculation	Total Revenue - Total Expenses	Total Revenue - Total Cost of Production
Includes Implicit Costs	Yes (as part of total expenses)	Yes (as part of total cost of production)
Used For	Financial reporting and tax purposes	Business decision-making and economic analysis

FAQ

What is the difference between accounting profit and economic profit?

Accounting profit is the net income reported on financial statements, while economic profit considers the opportunity cost of capital. Economic profit is generally lower than accounting profit because it accounts for the cost of capital that could have been earned elsewhere.

Why is economic profit important for businesses?

Economic profit is important because it provides a more accurate measure of a business's profitability, considering the opportunity cost of capital. It helps businesses make informed decisions about expansion, investment, and resource allocation.

Can accounting profit be negative while economic profit is positive?

Yes, it's possible for accounting profit to be negative while economic profit is positive. This can happen if the company's explicit costs are higher than its revenue, but the opportunity cost of capital is lower than the explicit costs.