Many businesses would love to know what is economic profit. The only way they could find out the answer to this is if they knew something about economics. Most people have no idea what is economic profit. If you think about it though, every business operates using a similar formula and as such it is fairly easy to figure out what is economic profit according to the business model used by each individual entrepreneur. Every entrepreneur knows what their business is going to earn them in time.
A great way to get a better understanding of what is economic profit and how it applies to your business is through an accounting profit & loss analysis. An accounting profit and loss analysis are a comprehensive and thorough examination of a company’s operations that presents all kinds of details regarding how their profits are made. It is an excellent way to examine all aspects of your company and learn how everything is being spent.
There are many different components that go into calculating what is economic profit. Some of these components include gross profit, opportunity cost per unit, and net profit. Gross profit is just what it says. It is simply the value of your product divided by the cost of production. Opportunity cost per unit refers to the cost of creating the product in relation to the opportunity cost per unit that would exist if the product were sold to customers in the marketplace.
The third component that is part of what is economic profit is called explicit costs. This includes expenses that arise from the production of your product, such as overhead, transport, raw materials, labor, etc. An accounting profit and loss analysis will not be complete without the inclusion of these implicit costs. Implicit costs refer to those which arise from the decision of where to locate the headquarters of your company. All other things being equal, the firm that has the most favorable implicit cost structure will have an advantage in determining what is economic profit.
The last component that is included in what is economic profit and what is the accounting profit and loss analysis is what is referred to as opportunity cost. Opportunity cost is basically money being spent that is not captured by the firm in the production of their product or service. In other words, it is money that is not spent on the firm’s goods or services but rather on activities that do not relate to the firm’s goods or services. Opportunity cost per unit can be calculated by the firm by dividing the total firm cost, including all opportunity costs, by the firm’s average sales per unit. If the result is greater than one-half, then the opportunity cost per unit is considered to be a part of what is economic profit.
What is economic profit can also be determined by analyzing what is the profit margin on a product when all factors of what is economic profit are taken into account. Again, examining the accounting profit and loss framework will help in determining what is the profit margin for a firm. If a firm has a high level of production that represents economic profit but a relatively low level of marketing cost, then there is an opportunity cost in this case and so the firm would not capture all the value that it could if it did not have the incentive to increase its marketing cost. On the other hand, if the firm has a high level of production but low level of marketing cost, then this represents a firm fixed cost that limits its ability to increase its sales.
Analysis what is economic profit and what are the accounting profit and loss framework are also affected by what is called the explicit costs or exogenous factors that can increase or decrease the overall value of the firm. This includes the sum of all direct and indirect costs that enter into the firm’s value adding process. For example, the indirect costs are costs such as travel time and supplies that affect the firm’s sale to customers and its inventory costs. Each of these costs can be allocated to a particular category which represents the firm’s potential to increase in value. Allocating exogenous factors to each category of what is economic profit and what is the accounting profit and loss framework will help in determining which costs can be passed on or that can be reinvested to increase the firm’s revenue.
Analysis what is economic profit and what is the accounting profit and loss framework can also be affected by a firm’s structure of ownership. Some firms have what is called an initial public offering (IPO) where they sell shares of their stock for a large amount of money at one time. Other firms may start out with shares of the firm and then issue convertible senior notes. Either way, shares of the firm’s stock will change hands from a firm owner to a shareholder or from a shareholder to the firm’s capital stock. All of these changes in ownership can affect the profits and losses. The value of the shares may decrease due to under performance by the firm or increase due to the ownership changes.