Key Differences Between Accounting Profit and Economic Profit

In microeconomics, accounting profit refers to a company’s earnings and is calculated by subtracting total costs (like monetary costs, operating expenses, material costs, and production costs) from total revenue. Accounting profit is the type of net income that accountants often refer to when using the term “profit,” in line with generally accepted accounting principles (GAAP), the set of principles that establishes consistent standards and procedures for accountants in the United States.

Accountants may include the accounting profit on an income statement, balance sheet, or another financial statement as the measurable “bottom line” or “bookkeeping profit” in an accounting period. Business owners and financial analysts use this metric to determine whether a business is generating enough positive cash flow to continue operating in line with its financial accounting and goals, or if they’re operating at an economic loss.

The formula for calculating accounting profit is as follows:

Accounting profit = General revenue – explicit costs

For example, a local bakery makes $10,000 a month in the cost of goods sold (in this case, selling doughnuts)—this is their general revenue. If the cost of raw materials (like ingredients) and other fixed costs (like rent and labor costs) equals $5,000 a month, then their accounting profit would be $10,000 minus $5,000, or $5,000.

In microeconomics, economic profit is the difference between a company’s total revenue from sales and its explicit and implicit costs. To calculate economic profit, accountants subtract general revenue from both the explicit costs (like operating costs) and implicit costs, or the total opportunity cost of using their factors of production for this business model instead of the next best alternative.

Gauging the market price of implicit costs (also called economic costs or imputed costs) can be difficult. To determine this figure, accountants have to guess the potential amount of money they could generate in a different business activity that they have chosen to bypass to operate in their chosen manner.

Economic profit is a more nuanced version of profit than accounting profit and is useful for aspiring businesspeople to determine if they want to enter a particular market. For instance, a positive economic profit suggests that the startup has chosen a profitable field. In contrast, a negative or zero economic profit suggests their capital may be better used in other ways.

The formula for calculating economic profit is as follows:

Economic profit = General revenue – explicit costs – implicit costs

For example, a local bakery makes $10,000 a month selling doughnuts, which is their general revenue, and their monthly operating costs (for ingredients and rent) are $5,000. The bakery knows that if they chose not to make doughnuts and instead rented out their culinary equipment (which they already own) to other bakeries, they would make $2,500 a month. Thus, their economic profit would be $10,000 minus $5,000 minus $2,500, or $2,500.

For economists, accounting profit and economic profit are closely related but have a few key differences:

• Formula: Accounting profit and economic profit differ in their formulas—while accounting profit uses only explicit costs and general revenue, economic profit includes one additional variable: implicit cost.
• Relationship: Since economic profit is a version of accounting profit with one additional variable subtraction, economic profit will always be equal to or lower than accounting profit—it will never be a larger number than the accounting profit.
• Uses: Accounting profit is a more straightforward number of profitability that businesses can use to assess their financial health and decide if they’re making enough “normal” profit to continue operating. Economic profit is a more nuanced number that considers the opportunity cost of operating to help businesses decide if it’s worth it to enter into the market or switch their business model.

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