Economic profit refers to the gap that arises between the revenue received from a transaction and the expenses necessary to provide services or manufacture produces. When calculating it, businesses should deduct economic profits, opportunity costs as well as explicit costs.
Explanation:
When companies calculate their economic profits, they usually consider accounting profits as well. When comparing economic vs accounting profit, the latter is the type of profit that is shown on the income statement. It is used for measuring both inflows and outflows that are required as an aspect of financial transparency.
The other kind of profits is not recorded on financial statements and is not necessarily reported to regulatory or other financial institutions. It is necessary to conduct an analysis that would indicate a particular decision of a company that would bring a profit for a business in terms of its overall economy.
The economic profit formula is: Profit = revenues – explicit costs – opportunity costs.
This kind of profit is used when businesses aim to compare it with the income that would have been potentially acquired from selecting a different option. With large organizations, managers usually look more specifically at net, gross, and operating profits at various phases of operations.
Thus, economic profit definition refers to the theoretical measurement of actual revenues together with opportunity costs. Looking at implicit costs is necessary to review the impact of past decisions and finding a more optimal course of action to be taken. Thus, economists and managers employ economic profit to ensure that they have made the correct choice between the initial project and the following project after the fact.