In entrepreneurship, profit is the primary reward for organizing and managing a business. However, profit is not a singular concept—it can be analyzed from different perspectives based on accounting, economic, and financial principles. Recognizing the different types of profit helps entrepreneurs assess their venture’s performance, sustainability, and efficiency.
1. Accounting Profit
- Definition: The total revenue earned by a business minus its explicit costs (i.e., actual out-of-pocket expenses such as rent, salaries, raw materials, utilities, etc.).
- Formula: Accounting Profit = Total Revenue – Explicit Costs
- Purpose: Used in financial statements to assess taxable income and financial health.
- Example: If a business earns RM500,000 in sales and spends RM350,000 in direct expenses, the accounting profit is RM150,000.
2. Economic Profit
- Definition: The difference between total revenue and the sum of explicit and implicit costs (opportunity costs of capital, time, and resources).
- Formula: Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs)
- Purpose: Measures the true profitability and value-added of a business by accounting for foregone opportunities.
- Example: If the same business’s owner could earn RM100,000 working elsewhere, the economic profit would be RM150,000 – RM100,000 = RM50,000.
3. Normal Profit
- Definition: The minimum level of profit required to keep an entrepreneur in the current business; it is considered part of the opportunity cost.
- Implication: If a business earns only normal profit, it is covering all its costs (explicit and implicit), but not making excess returns.
- Economic Interpretation: When economic profit = 0, the business is still viable because it’s covering normal profit.
4. Supernormal (Abnormal) Profit
- Definition: Profit earned above and beyond the normal profit level, often due to innovation, monopoly power, or cost advantages.
- Implication: Indicates a highly successful venture or temporary market dominance.
- Policy Concern: In some cases, sustained supernormal profits may attract regulatory scrutiny or competitors.
5. Gross Profit
- Definition: Revenue from sales minus the cost of goods sold (COGS), excluding administrative or operating expenses.
- Formula: Gross Profit = Revenue – COGS
- Purpose: Measures the core profitability of producing and selling goods before overheads.
6. Net Profit
- Definition: The profit remaining after all expenses—operating, financial, and taxes—are deducted from total revenue.
- Formula: Net Profit = Total Revenue – Total Expenses
- Use: Represents the bottom line and is often used to determine business success and distribute dividends.
Understanding Profit Types to Evaluate Entrepreneurial Performance
Each type of profit offers a unique lens through which entrepreneurs can evaluate the financial viability and strategic value of their ventures. While accounting profit tracks operational results, economic and supernormal profit highlight broader opportunity costs and competitive strength. Mastering these distinctions helps entrepreneurs make informed decisions, attract investment, and pursue sustainable growth.