Profit and Functions of Profit

# Profit

The word 'profit' is very vague term, it may mean different to different people. Some of them are : 

• Gross Profit
• Net Profit
• Real Profit
• Notional Profit
• Marginal Profit
• Economic Profit
• Accounting Profit
• Profit Before Tax 
• Profit before adjustment of Extra-ordinary Items 
• Capital Profit and so on

But in economic sense, 

It is the reward for the entrepreneurs for contribution of their capital. It is the sign of efficiency in production. when we talk about profit as a economic point of view, we mean economic profit.

Mathematically, 

Economic Profit = Total Sales Revenue (TR) - Economic Cost (EC)

Total Sales Revenue is the total collections made by selling the product or service. It includes Product Cost as well as desired amount of profit by the entrepreneurs. It is the product of unit price of commodity with volume of sales.

Mathematically, 

TR = Price of Commodity (P) x volume of Sales ( Q )

Similarly, 

Economic Cost are those cost, that a firm pays implicitly as well as explicitly. In simple words, it is the sum of implicit cost and explicit cost. It includes all the cost related to the product as well as any opportunity cost incurred therein. Economic Costs are the cost at which the firm is able to cover its product cost as well as the normal return on its owned resources as a part of cost.  

Mathematically, 

Economic Cost = Explicit Cost + Implicit Cost = Accounting Cost (as mentioned below ) + Implicit Rent + Implicit Wages + Implicit Interests + Any Entrepreneurs opportunity Cost

where, 

Accounting Cost  =  Direct Material + Direct Labor + Direct Overheads + Indirect Expenses + Selling and Distribution Expenses + Administrative Expenses + Legal Expenses + Management Expenses + Staff Expenses + Other Fixed and Variable Cost + Miscellaneous Expenses

It is rational to take business decision on the basis of economic profit rather than business profit. Since, Business profit considers only accounting cost but economic profit considers both accounting costs as well as implicit costs.

The rate of profits differ from firms to firms and industry to industry. For example, the rate of profits earned in steel and textile industry is lower than the rate of profits of firms in pharmaceutical, office supplies and high-tech industries. 

Why it is so ?

Actually, there are several theories that tries to explain the reason of differences. Some of them are :

• Risk-Bearing Theory of Profit 

Under this theory, the difference is because the above-normal returns and above-risks are required to enter the firms and remain in the same field. 

• Frictional Theory of Profit 

Under this theory, the difference is due to profits arises due to friction or disturbances from long-run equilibrium. Therefore in long-run the firms will either get normal profit or zero profit.

• Monopoly Theory of Profit

Under this theory, the difference is due to imposing restriction in the output and charging higher prices.

• Innovation Theory of Profit 

Under this theory, the difference is due to introduction of successful Innovation.

• Managerial Efficiency Theory of Profit 

Under this theory, the difference is because in long-run more efficient firms earns above-normal returns and economic profit.

# Functions of Profit :

Profits are required for survival of any business. Some of the functions of profits are as follows:

• It helps to evaluate the performance of the business.

• Profits attracts new business.

• It helps to supply of future capital.

• Profits increases efficiency.

• It helps in decision making.

• It helps to determine wages and salaries.

• It supports Investment decisions.

• It helps to determine extra facilities (like, bonus, commissions, provident fund, gratuity ).

• It helps in planning of human resource.

• It helps for expansion of business.

• It helps to meet legal compliance.

• It helps to setup strategy.

• It encourage factors of production.

Note :

Click on these links for -

• Managerial Economics or Business Economics
• Difference between Managerial Economics and Traditional Economics
• Characteristics of Managerial economics and Role of Managerial Economics in Business Decision Making 
• Is Sales Revenue Maximization Model is better than Profit Maximization Model
• Practical approach towards Profit Maximization and Boumol's Sales Revenue maximization Model
• Practical Approach to Accounting Cost and Economic Cost
• Practical Approach to Moving Average in Managerial Economics 
• Case Study for Demand Forecasting