Accounting Profit vs. Economic Profit

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

In this lesson you will learn the differences between accounting profit and economic profit. You'll be able to calculate both and understand why accounting profit is usually larger than economic profit.

Accounting Profit

Suppose you run a cake decorating business. You need to keep track of your accounting so that you can report your earnings. Accounting profit is one of the critical numbers that potential investors, as well as the IRS, will be looking at. This is the number that is used when you file your taxes. It is your gross revenue minus your explicit costs. Explicit costs are all your deductible expenses. For example, your total revenue for last year is $250,000, and your explicit costs are $25,000. Your accounting profit is $250,000 - $25,000 = $225,000.

Economic Profit

Your economic profit is a little bit different. This number subtracts both your explicit costs and your implicit costs from your total revenue. Your implicit costs include costs that aren't seen on paper. Implicit costs are also called opportunity costs. These costs include things like how much you would be able to earn at another job, or the potential interest you could earn if you invested your company's money elsewhere. Implicit costs also incorporate the costs of owning your own buildings or machines. Along with implicit costs, you can also have implicit revenues, like the value of being your own boss. This may be worth quite a bit of money to you. This is added to your total revenue.

Returning to your cake decorating business, your total revenue for last year was $250,000. Your explicit costs were $25,000. Your implicit cost was $60,000 (your salary if you were working for somebody else). Your implicit revenue was $20,000 (the financial value of being your own boss). Your economic profit is $250,000 + $20,000 - $25,000 - $60,000 = $185,000. (total revenue + implicit revenue - explicit costs - implicit costs = economic profit)

As you can see, your economic profit is much less than your accounting profit. You can also see that being your own boss allows you to earn much more than working for someone else.

Now, the question remains, why do you need both of these numbers? Well, the first, your accounting profit, is obvious. You need it for taxes and to show investors. Your economic profit, on the other hand, is more useful as a means to judge whether a certain business is worth it from more than a financial standpoint.


Let's take a look at another example.

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