Economic Profit vs. Accounting Profit (With Formulas)

By Indeed Editorial Team

Published 7 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Economic and accounting profit are two common ways that companies measure their overall income. These metrics allow investors and higher management to make sound business decisions and keep track of their organisation's overall financial health. Knowing the difference between these two metrics can help you determine which one is most appropriate in certain situations. In this article, we explore what economic profit vs. accounting profit is, look at the difference between the two and provide formulas and examples of each.

Economic profit vs. accounting profit

Understanding the similarities between economic profit vs. accounting profit can help you understand when to use each one effectively:

Economic profit

Economic profit is how much a company makes after subtracting costs and expenses from its overall bottom line. It includes the money made from services and goods production, in addition to how the company used its resources in different ways. Components factored into this type of profit include implicit costs and opportunity costs brought in over a specific time period. Companies calculate economic profit when they know the total amount of income and how much that revenue costs to earn.

Examples of implicit or opportunity costs include:

  • depreciation of assets or goods

  • equipment needed for the production process

  • loss of interest on funds

  • time spend training a new employee

  • owners not taking a salary

  • selecting internal resources vs. getting paid

Accounting profit

Accounting profit is a company's net income, which is the total revenue minus any actual expenses or costs. This metric incorporates only explicit costs, which are listed on an income statement and involve physical assets or expenses. Explicit costs include expenses such as raw materials, staff expenses and purchasing assets. You can typically capture accounting profit over time, such as quarterly or annually. Expenses and costs that are subtracted from the total revenue include:

  • raw materials

  • inventory required for production

  • labour expenses

  • sales and marketing expenses, such as advertising

  • overhead costs

  • production costs

  • storage and transportation expenses

Accounting profit is how much money remains after misusing the explicit costs of overseeing and handling a company. Explicit costs relate to any expenses a company pays for during a set period of time. Companies typically refer accounting profit to as net income. It's most often calculated on a quarterly or annual basis and helps measure a company's overall financial performance.

Related: What Are Accounting Standards and Why Are They Important?

Differences between economic and accounting profit

While similar, these two metrics have several important differences to understand when calculating them. Some of these differences include:

Financial principles

Financial principles are the rules and guidelines that companies follow when reporting data. Each profit model follows different principles. Understanding these principles is key when accurately calculating each type of profit and include:

Accounting principles

Accounting principles help keep information clear and accurate in different industries and companies. This helps accountants and investors access and understand numbers from different companies or different time periods. Some of the accepted accounting principles (GAAP) that guide accounting profit are:

  • Consistency: Accountants report metrics consistently over each period to show progress. Accountants also explain any changes made to their reporting to keep information consistent.

  • Time period: Accountants follow their industry's reporting structure by reporting all profits and losses within specific time frames. This lets companies and investors track and evaluate their success frequently and helps them identify highs and lows within accounting periods.

  • Continuity: Accountants measure assets and profits while the business continues to operate.

  • Good faith: Accounting principles advise companies to always report their numbers with integrity and honesty.

Economic principles

Economic principles are some of the common theories that motivate market and economic activity. Financial professionals base their decisions on assumptions, such as:

  • Cost: In economic principles, the cost of something is what you give up to receive it. This can affect economic profit depending on if the cost of something is lower during certain time periods or if the value changes based on market conditions.

  • Incentives: Another economic principle is that people respond to incentives, which can affect economic profit if you offer incentives that take away from potential sales. Long-term benefits might increase overall profits, but you might factor in these implicit costs.

  • Margins: Economist principles state people think at the margin, which means people always think about their next step. In economics, this can relate to investments because what worked for customers before might not always work for customers in the future.

  • Tradeoff: This principle implies that people must give something to receive something else. With economic profit, the tradeoff might be implicit, like providing discounts to receive customer loyalty.

Based on these assumptions, the economic principles may determine implicit costs which then affect economic profit. For example, if you provided free merchandise for a promotional deal, you may no longer make those sales, as you give the items away. You might calculate the potential sales of these items and factor this into the implicit cost, which can change your economic profit.

Related: Positive vs. Normative Economics: A Detailed Comparison

Implicit costs

Implicit costs are a type of opportunity cost that relates to the decisions and ideas made by a company, as opposed to physical products or services. For example, if an organisation chooses to minimise its overall income, it's considered an implicit cost. While account profit factors in actual costs and expenses, economic profit also incorporates the implicit costs into its formula.

Related: Gross Profit vs. Net Profit: What Are the Differences?

Benefits of these metrics

Benefits vary for both economic profit and accounting profit calculations within a company. Accounting profit may show an increased number compared to economic profit and is often used to showcase an organisation's bottom line. It also shows the actual earnings within a specific time period.

Economic profit allows for more information regarding the company's operations. While the number is often lower, it shows how a company allocated its resources and evolved with any changes in the market. It can also demonstrate whether a company was successful after incorporating implicit costs.

Reporting

In many cases, it's considered that economic profit comes from estimated potential monetary losses. For example, a company may potentially lose an opportunity to make money when they choose to use discounts for products. This type of profit is also not often found on statements or other financial documentation.

Accounting profit considers calculable and measurable losses of income, known as explicit costs. For example, an explicit cost may include the amount of money spent on raw materials needed to produce a product. Companies often report these types of profits on income statements and when filing taxes.

Formula for economic and accounting profit

The following are the formulas used to calculate economic and accounting profit:

Economic profit

Here's the formula to determine economic profit for a company:

Total revenue - Implicit costs + Explicit costs = Economic profit

Accounting profit

The following is the formula used to calculate the accounting profit:

Total revenue - Explicit costs = Accounting profit

Related: How to Calculate Net Profit Margin in 4 Simple Steps

Examples of accounting profit

The following are examples of how to calculate accounting profit:

Example 1

Here's an example of a positive accounting profit:

Explicit costs:

  • Cost of materials: HK$30,000

  • Cost of labour: HK$35,000

Revenue:

  • Product sales: HK$80,000

Total revenue - explicit costs

HK$80,000 - HK$65,000 = HK$ 15,000

Example 2

Here's an example of a negative accounting profit:

Explicit costs:

  • Cost of materials: HK$40,000

  • Cost of labour: HK$20,000

Revenue:

  • Product sales: HK$50,000

Total revenue - explicit costs

HK$50,000 - HK$60,000 = -HK$10,000

Example of economic profit

The following are two examples of negative and positive economic profits:

Example 1

Here's an example of a positive economic profit:

Implicit costs:

  • Depreciation of machinery: HK$10,000

  • Factory expansion: HK$50,000

Explicit costs:

  • Labour: HK$ 10,000

  • Production: HK$20,000

Total revenue: HK$110,000

Total revenue - (implicit costs + explicit costs)

HK$110,000 - (HK$ 60,000 + HK$30,000) = HK$20,000

Example 2

Here's an example of a negative economic profit:

Implicit costs:

  • Depreciation of machinery: HK$20,000

  • Foregone salary: HK$20,000

Explicit costs:

  • Labour: HK$30,000

  • New assets: HK$20,000

Sales: HK$80,000

Total revenue - (implicit costs + explicit costs)

HK$80,000 - (HK$40,000 + HK$ 50,000) = -HK$10,000

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