Q:

What Is economic profit?

A:

Quick Answer

Economic profit is the total revenue generated by a business minus total opportunity costs. It is a more theoretical way of looking at a company's profitability that differs from the standard accounting profit reflected on the company's income statement, which simply subtracts the cost of producing goods and services from total revenue.

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Full Answer

Accounting for profit ordinarily involves evaluating actual revenue that came into the business against actual expenses that were paid. Another way of looking at overall profitability is to assign a cost to the opportunities that the business couldn't capitalize on, known as the total opportunity cost. Lost opportunities include such things as the difference in a discount the company could have received on raw materials if it had the cash flow to buy in bulk and other business opportunities or adjustments that would have increased profitability under ideal circumstances.

Economic profit, also known as economic value added, is almost always lower than actual profit because it factors in scenarios that resulted in the business making less profit than it could have optimally made. Considering economic profit along with actual profit allows a company's stakeholders to evaluate the performance of the people running the business, since opportunity cost often reflects management decisions made to direct operations.

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