Accounting Profit: Definition & Formula

Accounting Profit: Definition & Formula
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

In this lesson, you'll learn what accounting profit is and why it's important in the world of finance and business. You'll also examine some of the basic terminologies and the most common financial statements that include accounting profit.

Understanding Accounting Profit

As a manager, leader or owner of a business, you likely have to look at financial statements on a monthly or quarterly basis. A basic requirement in many of these positions is a strong understanding of the accounting profit of your business. Accounting profit, in simple terms, is the revenue of a company minus the explicit costs of a company. It's also often the same as or very closely related to the net income on a financial statement.

Net income is the profit, the bottom line, and is always found toward the bottom of the income statement. It is easily the most watched number in finance. Accounting profit is calculated using methods and principles set by authoritative policy boards referred to as Generally Accepted Accounting Principles (GAAP).

You may be wondering what exactly are explicit costs. Explicit costs are operating expenses that are easily identified and accounted for, such as raw materials, wages paid to employees, interest on loans for equipment and buildings, rent, utilities, and taxes. It's important to note that sometimes accounting profit will be displayed as a net profit before taxes.

The best way to see what goes into accounting profit is to look at an income statement, which is also commonly called a profit and loss statement. This statement is one of the main financial statements of a company and shows the company's revenue and expenses during a particular period.

Accounting Profit Formulas

  • The basic profit formula is Total Revenue - Explicit Costs.
  • The detailed profit formula is Total Revenue - Cost of Goods Sold = Gross Profit.
  • Gross Profit - (Operating Expenses + Taxes) = Accounting Profit
  • Accounting Profit = Total Revenue - (Cost of Goods Sold + Operating Expenses + Taxes)

Accounting Profit vs. Economic Profit with Examples

Accounting profit is different than economic profit, which includes such things as opportunity cost. Unlike explicit costs that can be easily calculated, an opportunity cost is a potential source of profit that was lost by pursuing another course of action. Hence, it is also often referred to as implicit costs.

Consider this simplified example of the difference between accounting profit and economic profit. In one year, a company made $100,000 in sales and paid $60,000 in total expenses and taxes. The accounting profit would be $40,000 ($100,000 in revenue - $60,000 in explicit costs). However, if the firm could have made $50,000 by renting some of its land and equipment, its economic profit would be a loss of $10,000 ($100,000 in revenue - $60,000 in explicit costs - $50,000 in opportunity costs). That's quite a difference!

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