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.
The main elements of gross profit of a firm are as under:
Elements and Example
of Gross Profit:
(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 capita!. 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)
