Profit, in
accounting
Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
, is an
income
Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. For ...
distributed to the
owner in a
profitable market production In a general sense, market production refers to the production of a product or service which is intended for sale at a money-price in a market. The product or service in principle has to be tradable for money.
However, in national accounts the te ...
process (
business
Business is the practice of making one's living or making money by producing or Trade, buying and selling Product (business), products (such as goods and Service (economics), services). It is also "any activity or enterprise entered into for pr ...
). Profit is a measure of
profitability
In economics, profit is the difference between the revenue that an economic entity has received from its outputs and the total cost of its inputs. It is equal to total revenue minus total cost, including both explicit and implicit costs.
It i ...
which is the owner's major interest in the income-formation process of market production. There are several profit measures in common use.
Income formation in market production is always a balance between income generation and
income distribution
In economics, income distribution covers how a country's total GDP is distributed amongst its population. Economic theory and economic policy have long seen income and its distribution as a central concern. Unequal distribution of income causes ec ...
. The income generated is always distributed to the
stakeholders of production as
economic value
In economics, economic value is a measure of the benefit provided by a good or service to an economic agent. It is generally measured through units of currency, and the interpretation is therefore "what is the maximum amount of money a speci ...
within the review period. The profit is the share of income formation the owner is able to keep to themselves in the income distribution process. Profit is one of the major sources of
economic well-being
Well-being, or wellbeing, also known as wellness, prudential value or quality of life, refers to what is intrinsically valuable relative ''to'' someone. So the well-being of a person is what is ultimately good ''for'' this person, what is in th ...
because it means incomes and opportunities to develop production. The words "income", "profit" and "earnings" are synonyms in this context.
Measurement of profit
There are several important profit measures in common use. Note that the words ''earnings'', ''profit'' and ''income'' are used as substitutes in some of these terms.
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Gross profit equals sales
revenue
In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business.
Commercial revenue may also be referred to as sales or as turnover. Some companies receive reven ...
minus
cost of goods sold
Cost of goods sold (COGS) is the carrying value of goods sold during a particular period.
Costs are associated with particular goods using one of the several formulas, including specific identification, first-in first-out (FIFO), or average cost. ...
(COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.
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Earnings before interest, taxes, depreciation, and amortization
A company's earnings before interest, taxes, depreciation, and amortization (commonly abbreviated EBITDA, pronounced , , or ) is a measure of a company's profitability of the operating business only, thus before any effects of indebtedness, sta ...
(EBITDA) equals sales revenue minus cost of goods sold and all expenses except for interest, amortization, depreciation and taxes. It measures the cash earnings that can be used to pay interest and repay the principal. Since the interest is paid before income tax is calculated, the debt holder can ignore taxes.
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Earnings before interest and taxes
In accounting and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses (operating and non-operating) except interest expenses and income tax expenses.
Operating income and op ...
(EBIT) or operating profit equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations. It is also known as Operating Profit Before Interest and Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT).
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Earnings before taxes
In accounting and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses (operating and non-operating) except interest expenses and income tax expenses.
Operating income and ope ...
(EBT) or net profit before tax equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes or simply pre-tax income.
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Net income
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, a ...
or earnings after tax or net profit after tax equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the US, the term
net income
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, a ...
is commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.
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Retained earnings
The retained earnings (also known as plowback) of a corporation is the accumulated net income of the corporation that is retained by the corporation at a particular point of time, such as at the end of the reporting period. At the end of that peri ...
equals earnings after tax minus payable
dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-in ...
s.
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 earnings after tax less the ''equity charge'', a risk-weighted cost of capital. This is almost identical to the economists' definition of economic profit.
There are analysts who see the benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by
Eugen Schmalenbach
Eugen Schmalenbach (20 August 1873 – 20 February 1955) was a German academic and economist. He was born in Halver, and attended the Leipzig College of Commerce starting in 1898. That college later became part of Leipzig University, only to e ...
, 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
Economic Value Added (EVA).
Optimum profit is a theoretical measure and denotes the "right" level of profit a business can achieve. In the business, this figure takes account of
marketing
Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to emph ...
strategy,
market position
Market is a term used to describe concepts such as:
* Market (economics), system in which parties engage in transactions according to supply and demand
* Market economy
*Marketplace, a physical marketplace or public market
Geography
*Märket, a ...
, and other methods of increasing returns above the competitive rate.
Accounting profits should include economic profits, which are also called
economic rent
In economics, economic rent is any payment (in the context of a market transaction) to the owner of a factor of production in excess of the cost needed to bring that factor into production. In classical economics, economic rent is any payment m ...
s. For instance, a
monopoly
A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...
can have very high economic profits, and those profits might include a rent on some natural resource that a firm owns, whereby that resource cannot be easily duplicated by other firms.
Other terms
See also
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Gross income
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Net profit
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, ...
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Profitability index
Profitability index (PI), also known as profit investment ratio (PIR) and value investment ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for ranking projects because it allows you to quantify the amo ...
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Rate of return
In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest payments, coupons, cas ...
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Return on assets The return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue.
ROA can be computed as below:
:\mathrm = \frac
This number tells you what the company can do with what it has, ''i.e.'' how many doll ...
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Return on equity
The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on ''a ...
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Rate of profit
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Profit model
The profit model is the linear, deterministic algebraic model used implicitly by most cost accountants. Starting with, profit equals sales minus costs, it provides a structure for modeling cost elements such as materials, losses, multi-products, ...
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Profit motive
Footnotes
References
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Further reading and external links
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*Moroney, J. R. (1967) Cobb-Douglass production functions and returns to scale in US manufacturing industry, ''Western Economic Journal'', vol 6, no 1, December 1967, pp 39–51.
*Pearl, D. and Enos, J. (1975) Engineering production functions and technological progress, ''The Journal of Industrial Economics'', vol 24, September 1975, pp 55–72.
*Robinson, J. (1953) The production function and the theory of capital, ''Review of Economic Studies'', vol XXI, 1953, pp. 81–106
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Anwar Shaikh, "Laws of Production and Laws of Algebra: The Humbug Production Function", in The Review of Economics and Statistics, Volume 56(1), February 1974, p. 115-120. https://web.archive.org/web/20050518113632/http://homepage.newschool.edu/~AShaikh/humbug.pdf
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Anwar Shaikh, "Laws of Production and Laws of Algebra—Humbug II", in Growth, Profits and Property ed. by Edward J. Nell. Cambridge, Cambridge University Press, 1980. https://web.archive.org/web/20050518112119/http://homepage.newschool.edu/~AShaikh/humbug2.pdf
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Anwar Shaikh, "Nonlinear Dynamics and Pseudo-Production Functions", published?, 2008. http://college.holycross.edu/eej/Volume31/V31N3P447_466.pdf
*Shephard, R (1970) ''Theory of cost and production functions'', Princeton University Press, Princeton NJ.
*Thompson, A. (1981) ''Economics of the firm, Theory and practice'', 3rd edition, Prentice Hall, Englewood Cliffs.
*Elmer G. Wiens
Production Functions- Models of the Cobb-Douglas, C.E.S., Trans-Log, and Diewert Production Functions.
Profit and Loss Ludwig von Mises
Ludwig Heinrich Edler von Mises (; 29 September 1881 – 10 October 1973) was an Austrian School economist, historian, logician, and Sociology, sociologist. Mises wrote and lectured extensively on the societal contributions of classical liberali ...
(1951)
Measuring the Long-Run Profitability of the Firm Salmi and Virtanen (1997)
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