Economic profit is the difference between the total income received by a business and the sum of total explicit and implicit costs. Following this, economic profit can be calculated by the formulas:
- Accounting Profit = Total Revenues – Explicit Costs
- Economic Profit = Accounting Profit – Implicit Costs
You can also meet the following version that combines two formulas at the same time:
- Economic Profit = Total Revenues – (Explicit Costs + Implicit Costs).
Explanation:
Often, when talking about the income of a company, the firm talks about accounting income and not an economic one, which is an entirely different quantity. Accounting income is the difference between all total revenues of companies and all total apparent costs. Since only explicit costs are taken into account, it is impossible to speak of an objective assessment of company income using this parameter. Thus, it is necessary to use the formula for calculating economic profit.
Economic income is the difference between accounting income and opportunity costs, implicit costs, and losses of a company that is incurred by investing in an existing project. This type of income, unlike accounting, is not displayed in the financial statements of the company, but rather is an analysis of possible outcomes.
Since economic profit provides an estimate of the company’s income per missed opportunities and implicit costs, it can vary depending on the situation and different events. The following formula calculates it: Economic profit = Total Revenues – Explicit costs – Opportunity costs (or implicit costs).
The latter component is used for an in-depth analysis of various business solutions to select alternative development paths. In general, opportunity costs symbolize potential profit if the company chooses an alternative route.