Analysis of the activities of any business entity is carried out using two approaches, which are conventionally called economic and accounting. The second is based on an analysis of the costs that are recorded in the financial statements. For economic analysis, not only a set of real indicators of reports is used, but also opportunity costs, that is, a benefit that is recognized as lost.
Terminology features
Under accounting costs refers to actually made payments that are made to the documentation. If accounting expenses are deducted from the income received, then this will be the calculation of accounting profit. Further, it is required to deduct taxes and other obligatory payments from it, which results in net profit, and it serves as a reserve source of financing and is taken into account by tax authorities.
If accounting and economic profits are calculated, then you should know that in addition to accounting costs, implicit or internal, that is, the alternative cost of resources available to the entrepreneur, is added to economic costs. These internal costs are estimated based on the possibilities of alternative use.
For example, an entrepreneur can use his car for production purposes. Economists are convinced of the need to account for such costs, but accounting cannot do this, since there is no fact of payment from someone to someone. This is not reflected in accounting. On the part of economists, there may be an opinion that the car could be used differently, for example, an entrepreneur has the opportunity to rent it out, for which he will receive a rent. Therefore, economists recognize lost rents as internal costs.
Specifications
So, if accounting and economic profits are considered, it is worth noting that the latter personifies the difference between income and economic costs. To reduce the difference between economic and accounting costs, it is necessary to fix the costs in accounting as accurately as possible, although usually this difference cannot be reduced to zero. But even when the economic profit is less than accounting, and even tends to zero, the entrepreneur will continue to operate, getting accounting profit.
Historical development
Back in the 19th century, various types of profit were considered: accounting and economic, and then a rather strong difference between them was already obvious. It was then that Alfred Marshall developed the first indicator of economic profit. It was defined as the difference between net profit and the cost of owner’s capital, and all this was called residual income. While the calculations seem simple, in practice it turns out that it is necessary to find a whole array of information necessary for this.
The main emphasis of Alfred Marshall was on the fact that when determining the value formed by the company at a particular point in time, it is necessary to take into account not only the costs that are reflected in the accounting documentation, but also the opportunity costs associated with raising capital.
For a long time, the development of Marshall was unclaimed, and the value of economic profit was not so great. However, in the 80s of the last century, with the beginning of globalization and the outflow of capital to developing countries, different types of profit began to be considered: accounting and economic. They are used to demonstrate alternative indicators of company performance in order to attract more and more investors.
Economic profit
It was she who acted as one of such indicators through which new partners are attracted to the business. It assumes that the additional cost of invested capital will be created only when the amount of real income exceeds the opportunity cost of using this capital. The definition can be simplified as follows: economic profit exists only if the obtained financial result in fact exceeds all alternative ways of using the capital in question.
How to use the technique?
So far, the formation of enterprise profits is reflected only in accounting documentation. Economic profit has not taken root in the domestic practice of settlements, and there are several reasons for this. First of all, we are talking about ignorance of how to use this concept in decision-making by management personnel. Everyone is accustomed to analyzing accounting profits, so the activities of the enterprise are considered only through the prism of this factor. And those companies that have decided to use this method are faced with the task of adapting economic profits to tax and accounting standards.
Calculation Standards
Currently, the profit formula is used for calculations, which complies with international accounting and reporting standards, as well as American standards. They are completely compatible with each other, they use the same principles of accounting and reporting, and for certain issues in American standards the methodology is spelled out more clearly.
The requirements of international standards are aimed at bringing the legislation of the current system of standards for financial reporting and accounting into a harmonious state. It is generally accepted that it is useful to use it to characterize the results of enterprise activity of enterprises in a more realistic form. However, the American methodology is based on a larger number of developments; therefore, American companies tend to regulate operations quite clearly with less flexibility for each organization individually.
At the moment, economic profit is not reflected in the balance sheet at all, and its calculations are scientific or closed. The development of its widespread use is hampered due to the standardization of financial reporting and certain conservatism in accounting.
Elements of economic profit
When using the residual income indicator, which was proposed by Marshall, the companies had problems with comparing the initial data: capital costs will take into account the profitability received by the enterprise on the basis of market value, while net profit serves as an accounting term, calculated on the basis of accounting value. Naturally, the development of the world economy and market relations has led to the aggravation of disagreements between the market and accounting value of the enterprise, which made the use of the residual income indicator simply impossible.
Profit Types
Differing accounting, economic and normal profit. Typically, economic profit is the difference between total revenue and costs: external and internal. At the same time, normal profit is included in the number of internal costs, which personifies the minimum fee for retaining entrepreneurial talent. Profit, which is calculated on the basis of accounting information, represents the difference between income from various types of activities and external costs. Real profit is the income that remains in the accounts of the entrepreneur.
At the moment, accounting involves the use of five types of profit: gross, profit from sales, profit before tax, profit from ordinary activities, net profit. Gross - this is the difference between the proceeds from the sale of goods, works, products, services and the cost of sales of goods, works, services, products. The revenue that is received from the sale of goods, works, services and products is usually called income from ordinary activities. The profit formula in this case is as follows:
P (shaft) = BP - C, where BP is the revenue received from sales; C is the cost of sales.
Features of each type of profit
Profit from sales is gross profit minus selling and administrative expenses.
Profit before tax is the profit from sales , taking into account other expenses and income, which may be operating and non-operating. Operating income includes revenues that are related to the provision of the organization’s assets for temporary use. Non-operating income is recognized as fines, penalties, forfeits for violation of contractual terms, assets that were received free of charge, profit of previous years revealed in the reporting period.
Profits from ordinary activities are obtained by deducting mandatory payments and the amount of taxes from profit before tax.
Net income is the profit from ordinary activities in which extraordinary income and expenses are contributed. Extraordinary income means income that arises as a result of extraordinary circumstances of economic activity. Extraordinary expenses are understood as expenses associated with similar situations.
"Dance" from the costs
If accounting, economic and normal profit are considered, then it is worth noting that in general terms profit is defined as the difference between total revenue and total costs. This is the simplest and most common calculation option that can generally be applied.
Now you need to pay attention to the costs. Accounting and economic profit involves different approaches to their determination. The costs themselves can be external and internal. The former include payments to external providers. Subtracting them from the total revenue, you can get accounting profit. But she will not take into account the internal costs, which are usually attributed to:
- the costs associated with the resources owned by the enterprise itself;
- normal profit, which depends on the most important resource - entrepreneurial ability.
Economic profit is obtained after the internal costs are removed from the accounting.
The most obvious differences
It turns out that accounting profit is intended only for accounting for external costs, and economic profit is determined by subtracting also internal costs. In total, external and internal costs form economic, they are also called alternative. This means that in order to determine the amount of real profit, it is necessary to proceed from such a price of a resource that would be received by the owner with its best use. The formation of the profit of the enterprise in this case occurs regardless of the method of its calculation. But it is important to understand that the best option would be to increase precisely economic profit.