Meaning and Definition of Profit:
Profit is a basic concept in market economy. Profit acts as an incentive mechanism for business investment. Higher profits provide incentives for business growth. Profit also acts as an automatic signal for the allocation and reallocation of scarce resources. Profit which is the hub of all economic activities has no precise definition of its own. In fact it is the most controversial topic of economic theory. To get an accurate idea of profit, it is necessary to first distinguish gross profit from net profit.
Difference between Gross Profit and Net Profit:
Definition of Gross Profit:
Gross profit is the surplus which accrues to a firm when it deducts its total costs in producing products from its total income received from the sale of goods. In producing goods, a firm incurs explicit costs and implicit costs. In the ordinary language, the term profit is used in the sense of gross profit.
Elements and Example of Gross Profit:
The main elements and examples of gross profit of a firm are as under:
(i) Explicit costs: A firm’s explicit costs are the actual cash payments it makes to those who provide resources. For example, rent is paid on land hired, wages are paid to the employees, interest is paid on capital. In addition to this, a firm also pays insurance premium, and taxes and sets aside depreciation charges.
(ii) Implicit costs: Implicit costs are the opportunity costs of using resources owned by the firm or provided by the firm’s owners. To the firm, the implicit costs are the money payments that self employed resources could have earned in their best alternative uses.
For example, you are working as a manager in a shoe factory and getting $30000 per month as salary. Now you establish your own firm. You must include your salary of $30000, while calculating cost.
Implicit costs include (a) rent on entrepreneur’s own land (b) interest on his own capital (c) wage of the entrepreneur which he could earn in alternative occupation.
Formula for Gross Profit:
Gross Profit = Total Revenue – Total Explicit Costs
Definition of Net Profit:
Net profit is the profit which accrues to an entrepreneur for his functions as an entrepreneur. These functions include risk bearing ability, innovating spirit, bargaining ability etc. Net profit is the reward of an entrepreneur for:
(i) Organizing a business and undertaking risk (ii) his bargaining ability with the customers (iii) adopting new techniques of production (iv) monopoly gains if any (v) windfall gains due to sudden rise in the prices of goods.
Formula for Net Profit:
Net Profit = Total Revenue – (Total Explicit Costs + Total Implicit Costs)