Profit
Profit, from Latin meaning "to make progress", is defined in two different ways. Under
capitalism, profit is a positive return made on an investment by an individual or by
business operations. Under the
Marxist definition it is a mechanism of
class exploitation, where
surplus value is extracted by capitalists from their workers and suppliers beyond the point where costs are covered.
Under capitalism, methods of calculation differ between accountants and economists. Often, it is the difference between retail
sales price and the
costs of manufacture. However, the term is also used more generally to refer to the
value added after all the factors of production have been credited their full
opportunity cost.
The
profit motiveâ€"enterprises being free to make as much profit as they can given market conditionsâ€"is regarded by capitalists 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. Classical economists use profits to measure the happiness/utility/general welfare, gained by society, and understand that high profits demonstrate the high value of the factors used in the production of such goods.
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. This is sometimes referred to as
producer's surplus.
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.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 will succeed 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 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.
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. Within US business, the preferred term for profit tends to be the more ambiguous
income.
Gross profit is profit before Selling, General and Administrative costs (SG&A), like depreciation and interest; it is the Sales less direct Cost of Goods (or services) Sold (COGS),
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:
*
Abnormal (or supernormal profit)
*
Subnormal profit
*
monopoly profit (super 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.
There are commentators who see benefit in making adjustments to economic profit such as eliminating the effect of amortised goodwill or capitalising expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by
Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as EVA or
Economic Value Added.
*
Consumer surplus*
Economic Value Added*
Income*
superprofit*
surplus-value*
Tendency of the rate of profit to fall*
Measuring the Long-Run Profitability of the Firm, Salmi - Virtanen (1997)
