Profit (accounting)
Encyclopedia
In accounting, profit can be considered to be the difference between the purchase price
and the cost
s of bringing to market whatever it is that is accounted as an enterprise (whether by harvest, extraction, manufacture, or purchase) in terms of the component costs of delivered goods and/or services and any operating or other expenses.
Gross profit
equals sales revenue
minus cost of goods sold
(COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.
Earnings Before Interest
, Taxes, Depreciation
, and Amortization
(EBITDA
) equals sales revenue minus cost of goods sold and all expenses except for interest, amortization, depreciation and taxes. It measures the cash earnings that can be used to pay interest and repay the principal. Since interest is paid before income tax is calculated, the debtholder can ignore taxes.
Operating profit or Earnings Before Interest and Taxes
(EBIT) equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations. It is also known as Operating Profit Before Interest and Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT).
Earnings Before Tax (EBT) or Net Profit Before Tax equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes or simply pre-tax Income.
Earnings After Tax or Net Profit After Tax equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the US, the term Net Income
is commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.
Earnings After Tax (or Net Profit After Tax) minus payable dividends becomes Retained Earnings
.
To accountants, Economic Profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is Earnings After Tax less the Equity Charge, a risk-weighted cost of capital. This is almost identical to the economists' definition of economic profit.
There are analysts who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as Economic Value Added
(EVA).
Economists define also the following types of profit:
Optimum Profit is a theoretical measure and denotes the "right" level of profit a business can achieve. In business, this figure takes account of marketing
strategy, market position, and other methods of increasing returns above the competitive rate.
Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly
can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, whereby that resource cannot be easily duplicated by other firms.
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
and the cost
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...
s of bringing to market whatever it is that is accounted as an enterprise (whether by harvest, extraction, manufacture, or purchase) in terms of the component costs of delivered goods and/or services and any operating or other expenses.
Definition
There are several important profit measures in common use. Note that the words earnings, profit and income are used as substitutes in some of these terms (also depending on US or UK usage), thus inflating the number of profit measures.Gross profit
Gross profit
In accounting, gross profit or sales profit is the difference between revenue and the cost of making a product or providing a service, before deducting overhead, payroll, taxation, and interest payments...
equals sales revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
minus cost of goods sold
Cost of goods sold
Cost of goods sold refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out , or average cost...
(COGS), thus removing only the part of expenses that can be traced directly to the production or purchase of the goods. Gross profit still includes general (overhead) expenses like R&D, S&M, G&A, also interest expense, taxes and extraordinary items.
Earnings Before Interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
, Taxes, Depreciation
Depreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
, and Amortization
Amortization
Amortization is the process of decreasing, or accounting for, an amount over a period. The word comes from Middle English amortisen to kill, alienate in mortmain, from Anglo-French amorteser, alteration of amortir, from Vulgar Latin admortire to kill, from Latin ad- + mort-, mors death.When used...
(EBITDA
EBITDA
EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. It is a non-GAAP metric that is measured exactly as stated. All interest, tax, depreciation and amortization entries in the income statement are reversed out from the bottom-line net income...
) equals sales revenue minus cost of goods sold and all expenses except for interest, amortization, depreciation and taxes. It measures the cash earnings that can be used to pay interest and repay the principal. Since interest is paid before income tax is calculated, the debtholder can ignore taxes.
Operating profit or Earnings Before Interest and Taxes
Earnings before interest and taxes
In accounting and finance, earnings before interest and taxes is a measure of a firm's profit that excludes interest and income tax expenses. Operating income is the difference between operating revenues and operating expenses...
(EBIT) equals sales revenue minus cost of goods sold and all expenses except for interest and taxes. This is the surplus generated by operations. It is also known as Operating Profit Before Interest and Taxes (OPBIT) or simply Profit Before Interest and Taxes (PBIT).
Earnings Before Tax (EBT) or Net Profit Before Tax equals sales revenue minus cost of goods sold and all expenses except for taxes. It is also known as pre-tax book income (PTBI), net operating income before taxes or simply pre-tax Income.
Earnings After Tax or Net Profit After Tax equals sales revenue after deducting all expenses, including taxes (unless some distinction about the treatment of extraordinary expenses is made). In the US, the term Net Income
Net income
Net income is the residual income of a firm after adding total revenue and gains and subtracting all expenses and losses for the reporting period. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings...
is commonly used. Income before extraordinary expenses represents the same but before adjusting for extraordinary items.
Earnings After Tax (or Net Profit After Tax) minus payable dividends becomes Retained Earnings
Retained earnings
In accounting, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or...
.
To accountants, Economic Profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is Earnings After Tax less the Equity Charge, a risk-weighted cost of capital. This is almost identical to the economists' definition of economic profit.
There are analysts who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as Economic Value Added
Economic value added
In corporate finance, Economic Value Added or EVA, a registered trademark of Stern Stewart & Co., is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors . Quite simply, EVA is the profit earned by the firm less the cost of...
(EVA).
Economists define also the following types of profit:
- Abnormal profit (or Supernormal profit)
- Subnormal profit
- MonopolyMonopolyA monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
profit (or Super profit)
Optimum Profit is a theoretical measure and denotes the "right" level of profit a business can achieve. In business, this figure takes account of marketing
Marketing
Marketing is the process used to determine what products or services may be of interest to customers, and the strategy to use in sales, communications and business development. It generates the strategy that underlies sales techniques, business communication, and business developments...
strategy, market position, and other methods of increasing returns above the competitive rate.
Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, whereby that resource cannot be easily duplicated by other firms.
See also
- Gross profitGross profitIn accounting, gross profit or sales profit is the difference between revenue and the cost of making a product or providing a service, before deducting overhead, payroll, taxation, and interest payments...
- Net profitNet profitNet profit or net revenue is a measure of the profitability of a venture after accounting for all costs. In a survey of nearly 200 senior marketing managers, 91 percent responded that they found the "net profit" metric very useful...
- Profitability indexProfitability indexProfitability index , also known as profit investment ratio and value investment ratio , is the ratio of payoff to investment of a proposed project...
- Rate of returnRate of returnIn finance, rate of return , also known as return on investment , rate of profit or sometimes just return, is the ratio of money gained or lost on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or...
- Return on assets
- Return on equityReturn on equityReturn on equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity . ROE shows how well a company uses investment funds to generate earnings growth...
- Rate of profitRate of profitIn economics and finance, the profit rate is the relative profitability of an investment project, of a capitalist enterprise, or of the capitalist economy as a whole...
External links
- Profit and Loss, Ludwig von MisesLudwig von MisesLudwig Heinrich Edler von Mises was an Austrian economist, philosopher, and classical liberal who had a significant influence on the modern Libertarian movement and the "Austrian School" of economic thought.-Biography:-Early life:...
(1951) - Measuring the Long-Run Profitability of the Firm, Salmi - Virtanen (1997)