Alpha University College
Graduate Studies - MBA Program
1. Meaning of Profit:
Profit means surplus remaining after total costs are deducted from total revenue, and the basis on which tax is computed and dividend is paid. Profit is the money a business makes after accounting for all the expenses. A financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity 2. Concepts of Profit:
The two important concepts of profit in business decisions are ‘Economic profit’ and ‘Accounting profit’ 1.
2.1. Accounting profit:
Accounting profit figures consider realized or actual financial gains and losses. Accounting profit is the total of all the company's revenue minus cash payments for all explicit company costs and purchased resources. These resources include raw materials, materials transport, staff wages and benefits, rent paid on company property and interest on capital. Accounting Profit equals Sales Revenue minus all costs, which can be best explained in equation, Accounting profit = TR - (W + S + R + I + M)
TR = Total Revenue
R = Rent
W = wages
I = Interest
S = Salary
M = Material cost
As shown on the Accounting profit equation all costs considered in profit are actual costs which resulted in outflow of cash to acquire the service, such costs are called explicit costs.
2.2. Economic profit:
Unlike accounting profit, economic profit considers the cost of an organization's in-house resources that are utilized in their production of their goods or services. These items are also referred to in finance as implicit resources. Implicit or self-owned resources can include company-owned property, equipment, self-employment resources, company-owned vehicles and independently conducted staff training initiatives. Economic profit is differs from Accounting profit, in such a way that it takes into account the implicit or imputed costs. Implicit cost is opportunity cost that the investor foregone in terms of income which a businessman would have expected from the second best alternative use of his/her resources. Accounting profit = TR - Explicit cost (W + S + R + I + M) – Implicit cost (Opportunity Cost) For example if an entrepreneur uses his labor in his own business, he foregoes his income (salary), which he might earn by working as a manager in another firm. The Basic Differences: there are several differences that help define economic profit vs. accounting profit. First of all, while economic profit includes the opportunity cost, accounting profit does not take that into consideration. In other words, economic profits include both implicit costs (potential value of goods and services) and explicit costs (money directly paid), while accounting profits consider explicit costs and depreciation provisions. Accounting profits are computed for a particular time period (usually for a quarterly or annual report), and will almost always exceed the relative economic profit.
3. Theory of Profit
The concept of Profit has led to the emergence of theories of profit as the economist raise question, what are the sources of profit. The major theory of profit forwarded by various economists
3.1. Walker's Theory of Profit: Profit as Rent of Ability
This risk bearing theory of profit is associated with the name of F.B. Hawley. According to him: "Profit is the reward of risk taking in a business. During the conduct of any business activity, all other factors of production, i.e., land, labor and capital have their guaranteed incomes from the entrepreneur. They are least concerned whether the entrepreneur makes profit or undergoes tosses". In a business activity, as we know, there are every chance at any moment in the variation of demand for the commodity produced, The demand may change due to changes in fashion, tastes,...
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