What Is Accounting Profit?
Let me explain accounting profit directly: it's your company's total earnings, figured out using generally accepted accounting principles (GAAP). This includes subtracting the explicit costs of running your business, such as operating expenses, depreciation, interest, and taxes.
Key Takeaways
- Accounting profit shows the money left after deducting explicit costs of business operations.
- These explicit costs cover labor, production inventory, raw materials, transportation, production, and sales and marketing expenses.
- It differs from economic profit, which factors in implicit costs, and only accounts for monetary transactions.
- Accounting profit also contrasts with underlying profit, which removes nonrecurring items for a cleaner view.
How Accounting Profit Works
You know profit is a key metric for assessing a company's health, and firms often report different versions in their financial statements. Some include all revenues and expenses from the income statement, while others are more interpretive.
Accounting profit, or bookkeeping profit, is the net income after subtracting all dollar costs from total revenue. Essentially, it tells you what's left after covering the explicit costs of your operations. Consider costs like labor wages, production inventory, raw materials, transportation, sales and marketing, and overhead—these all factor in.
Accounting Profit vs. Economic Profit
Both accounting and economic profit deduct explicit costs from revenue, but economic profit goes further by including implicit costs—the opportunity costs of allocating resources elsewhere.
Think about implicit costs such as company-owned buildings, plant and equipment, or self-employment resources. For instance, if you invest $100,000 in a business and earn $120,000 in profit, your accounting profit is $20,000. But add an implicit cost like a $50,000 forgone salary, and economically, you're at a $30,000 loss.
Accounting profit is practical for taxes and measurable results, while economic profit is theoretical, helping you decide on alternatives.
Accounting Profit vs. Underlying Profit
Companies often present their own profit metrics, like underlying profit, which excludes one-time or infrequent items. This metric aims to strip away random events, such as natural disasters, to focus on regular operations.
Items like restructuring charges or property sales are ignored because they're not everyday costs. Pay attention to this if management highlights it—it's meant to give you a better sense of ongoing profitability.
Example of Accounting Profit
Take Company A in manufacturing, selling widgets at $5 each. In January, it sells 2,000 for $10,000 revenue—that's your starting point on the income statement.
Subtract cost of goods sold (COGS): at $1 per widget, that's $2,000, leaving $8,000 gross revenue. Then deduct operating costs, say $5,000 in employee expenses, for $3,000 operating profit (EBITDA).
Now factor in non-operating expenses: no debt, but $1,000 monthly depreciation, leading to $2,000 before taxes. With 35% taxes ($350), your accounting profit is $650. This step-by-step shows how it all adds up.
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