What is accounting profit?
Accounting profit is the total profit of a company, calculated according to generally accepted accounting principles (GAAP). It includes the explicit costs of doing business, such as operating costs, depreciation, interest and taxes.
How accounting profit works
Profit is a widely monitored financial measure that is regularly used to assess the health of a business.
Companies often publish different versions of their profits in their financial statements. Some of these figures take into account all income and expenditure goods, in the income statement. Others are creative interpretations developed by management and their accountants.
Book profit, also called book profit or financial profit, is the net income (NI) made after subtracting all dollar costs from total income. Indeed, it shows the amount of money a business has left after deducting the explicit costs of running the business.
The costs to be taken into account are:
- Work, like wages
- Inventory required for production
- Raw materials
- Transport costs
- Selling and marketing costs
- Production costs and overheads
Key points to remember
- The accounting profit indicates the amount of money remaining after deduction of the explicit costs of running the business.
- The explicit costs include labor, stocks needed for production and raw materials, as well as transport, production and sales and marketing costs.
- Accounting profit differs from economic profit because it represents only the monetary expenses that a company pays and the monetary income that it receives.
Accounting profit method
Let’s see an example of accounting profit calculation. Company A operates in the manufacturing industry and sells widgets for $ 5. In January, he sold 2,000 widgets for a total monthly income of $ 10,000. This is the first number entered in his income statement.
The cost of goods sold (COGS) is then subtracted from income to arrive at gross income. If it costs $ 1 to produce a widget, the company’s COGS would be $ 2,000 and its gross income would be $ 8,000, or ($ 10,000 – $ 2,000).
After calculating the gross revenue of the business, all operating costs are subtracted to arrive at the operating profit or the profit before interest, taxes, depreciation and amortization (EBITDA) of the business. If the only overhead costs for the business were a monthly expense of $ 5,000, its operating profit would be $ 3,000, or ($ 8,000 – $ 5,000).
Once a business earns operating profit, it then assesses all non-operating expenses, such as interest, depreciation, amortization, and taxes. In this example, the company has no debt but has depreciated its assets at a straight line depreciation of $ 1,000 per month. It also has a corporate tax rate of 35%.
The depreciation amount is first subtracted to obtain a profit before tax (EBT) of $ 1,000, or ($ 2,000 – $ 1,000). The corporate tax is then assessed at $ 350, to give the company an accounting profit of $ 650, calculated as ($ 1,000 – ($ 1,000 * 0.35).
Accounting profit vs economic profit
Like accounting profit, economic profit deducts explicit costs from revenues. Where they differ is that economic profit also uses implicit costs, the different opportunity costs that a company incurs when it allocates resources elsewhere.
Examples of implicit costs:
- Company owned buildings
- Facilities and equipment
- Freelance resources
For example, if a person invested $ 100,000 to start a business and made a profit of $ 120,000, their book profit would be $ 20,000. Economic profit, however, would add implicit costs, such as the opportunity cost of $ 50,000, which represents the salary he would have earned if he had kept his day job. As such, the business owner would suffer an economic loss of $ 30,000 ($ 120,000 – $ 100,000 – $ 50,000).
Economic profit is more a theoretical calculation based on alternative actions that could have been taken, while accounting profit calculates what really happened and the measurable results of the period. Accounting profit has many uses, including for tax returns. Economic profit, on the other hand, is mainly calculated to help management make a decision.
Accounting profit vs underlying profit
Companies often choose to supplement accounting profit with their own subjective perception of their profit position. One such example is the underlying profit. This popular and widely used measure often excludes one-time charges or infrequent events and is regularly flagged by management as a key number to which investors should pay attention.
The objective of the underlying profit is to eliminate the impact that random events, such as a natural disaster, have on income. Losses or gains that do not occur regularly, such as restructuring costs or the purchase or sale of land or property, are generally not taken into account as they do not occur often and therefore do not are not deemed to reflect daily costs. to manage the business.