Profit
- For the television series see Profit (TV series)
Profit is a positive return made on an investment by an individual or by business operations. The word comes from Latin meaning "to go forward."
It is a relatively ill-defined concept - methods of calculation differ between accountants and economists. Marxist economists refer to it as the 'surplus value' extracted by capitalists from their workers.
Profitability refers to the amount of profit received relative to the amount invested, often measured by a Rate of profit or Rate of return on investment.
Economists and accountants measure profit in slightly different ways. What is commonly known as profit is the difference between Sales and costs by a business enterprise. However, the term is also used more generally to refer to Value added, which only be the same when all the factors of production have been credited their full Opportunity cost.
The profit motive - enterprises being free to make as much profit as they can given market conditions - is often regarded to be a good thing. It is held to give firms incentives for Allocative efficiency and technical efficiency. This idea is a corollary of the theorems of Welfare economics and Utility maximisation. However, profits can include economic rents, which do not produce efficiency. For instance, a Monopoly can have very high profits but produce less economic Welfare.
Economic definitions of profit
Caution - these definitions are different from those used by accountantsIn Economics, a firm is said to be making an economic profit when its revenue exceeds the total opportunity cost of its inputs. It is said to be making an accounting profit if its revenues exceed the total price the firm pays for those inputs.
In a single-goods case, economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.
(In circumstances of Perfect competition, average cost = marginal cost at the profit-maximising position)
All enterprises constitute investments by their owners of capital. The return to owners' capital under competitive competition is the accounting profit and compensates the owner for not being able to make alternative use of their capital. It is the opportunity costs of a venture.
Accounting profit exceeds economic profit.
The accounting profit sometimes include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise wil lsucceed or not. In these cases, economists treat returns to risk as part of the accounting profit, as it is also an element of the cost of capital.
Economic profit does not occur in Perfect competition. Once risk is accounted for, long-lasting economic profit is thus viewed as an Inefficiency caused by monopolies or some other form of Market failure.
Economic profit is sometimes referred to as supernormal profit and accounting profit as normal profit.
The social profit from a firm's activities is the normal profit plus or minus any externalities that occur in its activity. A polluting oil monopoly may report huge profits, but be doing relatively little for the economy and damaging the environment. It would exhibit high economic profit but low social profit.
Accounting definitions of profit
Caution - these definitions are different from those used by economistsIn the accounting sense of the term, net profit (before tax) is the Sales of the firm less costs like as wages, rent, fuel, raw materials, interest on loans and Depreciation.
Gross profit is profit before depreciation and interest,
Net profit after tax is after the deduction of either corporate tax (for a company) or income tax (for an individual).
Operating profit is a measure of a company's earning power from ongoing operations, equal to earnings before the deduction of interest payments and income taxes.
To accountants, economic profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is the net profit after tax less the equity charge, a risk-weighted cost of capital. This is almost identical to the economist's definition of economic profit.
Some economists define further types of profit:
Optimum Profit - This is the "right amount" of profit a business can achieve. In business, this figure takes account of Marketing strategy, market position, and other methods of increasing returns above the competitive rate.