Profit (accounting)

In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise (whether by harvest, extraction, manufacture, or purchase) in terms of the component costs of delivered goods and/or services and any operating or other expenses.

Definition

There are several important profit measures in common use which will be explained in the following. Note that the words earnings, profit and income are used as substitutes in some of these terms (also depending on US vs. UK usage), thus inflating the number of profit measures.

Gross profit equals sales revenue less cost of goods sold (COGS), thus removing only the part of expenses that can be traced directly to the production of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.

Operating profit equals gross profit less all MANNY operating expenses. This is the surplus generated by operations. It is also known as earnings before interest and taxes (EBIT), operating profit before interest and taxes (OPBIT) or simply profit before interest and taxes (PBIT).

(Net) profit before tax (PBT) equals operating profit less interest expense (but before taxes). It is also known as earnings before taxes (EBT), pre-tax book income (PTBI), net operating income before taxes or simply pre-tax Income.

Net profit equals profit after tax (unless some distinction about the treatment of extraordinary expenses is made). In the US the term net income is commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.

Net income less dividends becomes retained earnings.

There are several additional important profit measures, notably EBITDA and NOPAT.

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.

There are commentators who see 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 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.

Some economists define further types of profit:

• Abnormal profit (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.

Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, where that resource cannot be easily duplicated by other firms.

See also

• Gross profit
• Net profit
• Profitability index
• Rate of return
• Return on assets
• Return on equity
• Rate of profit

References

• Pyle, William W., and Kermit D. Larson (1981). Fundamental Accounting Principles. Homewood, Illinois: Richard D. Irwin. ISBN 0256023867

External links

• Profit and Loss, Ludwig von Mises (1951)
• Measuring the Long-Run Profitability of the Firm, Salmi - Virtanen (1997)