Profit

(Redirected from Revenue)

The profit of a firm is simply the revenues it takes in minus the costs it incurs.[1] Because a firm is always incurring costs and taking in revenue, only when one the business is ended can the real profit be counted. While the firm is still operating, profits take over certain periods of time (monthly, quarterly, annually etc.) or can be assessed on a per-project basis.

Revenue is the total amount of money taken in by the sale of goods before the costs of production are subtracted. Revenue is sometimes referred to as gross profit.[2]


Profit = Total Revenue - Total Cost

Accounting Profit

This is the most basic of profit accounting method by considering the total revenue taken in by a firm minus the total costs. The costs can be for raw materials, interest payments, depreciation, labor costs, taxes and other production costs.[3]

Assume the costs for a firm are:

Type of Cost Amount ($)
Raw Materials 500,000
Labor 200,000
Interest 20,000
Depreciation 10,000
Taxes 50,000
Total Accounting Cost 780,000

If the firm takes in $1,800,000 in revenue then the accounting profit is:

Profit = $1,800,000 - $780,000
Profit = $1,020,000

Economic Profit

The economic profit takes into account the accounting costs plus the opportunity cost of using the input (material, labor etc.) to do one thing rather than another.[4] The opportunity cost is the cost of using funds, capital or resources to do one thing instead of another. For example, the $500,000 the firm spent on raw materials in the example above could have been used to buy a different type of raw materials or could have been invested to earn interest.

Opportunity Costs:

  • Economic depreciation - The amount of money that could have been saved by selling the capital owned by the firm before the time period started. If the firm above sold their capital before they start producing (when the equipment was new), it could save the amount that the equipment depreciated over time (1 year), $10,000.
  • Interest - The amount of money that the firm could have made if their funds were invested rather than spent on production. If the firm had invested its $500,000 and earned interest over the year then they could have had an additional $15,000. The firm chose to use this money to buy materials so it gave up the opportunity to invest the money.
  • Other opportunity costs include the cost of the owner using their entrepreneurial skills to run the firm instead of applying them to a different endeavour. The owner might work without taking a wage as well, the opportunity cost is the age that worker would normally earn.[4]


Type of Cost Amount ($)
Raw Materials 500,000
Labor 200,000
Interest 20,000
Depreciation 10,000
Taxes 50,000
Total Accounting Cost 780,000
Opportunity Costs
Economic Depreciation 10,000
Foregone Interest 15,000
Total Economic Cost 805,000

If the firm takes in $1,800,000 in revenue then the economic profit is:

Profit = $1,800,000 - $805,000
Profit = $995,000

Notice the difference between the accounting and economic profit is the opportunity cost, $25,000.

Profit Margin

The profit margin of a firm is the firms profit divided by its total sales in dollar amount, expressed as a percentage, the profit margin indicated how much of every dollar made is profit.[5]

Using the accounting profit from the example above:

Profit Margin = [math]\frac{Profit}{Revenue}[/math]
Profit Margin = [math]\frac{1,020,000}{1,800,000}[/math]
Profit Margin = 0.567
Profit Margin = 56.7%

For every dollar that the firm takes in from the sale of its products, it makes $0.56 in profit. Profit margins indicate the strength and earning potential of a firm, it is a measure that potential investors look at to help decide if they want to invest in the firm.[2]

References

  1. J.Black, N. Hashimzade, and G. Myles. (2009) "Profit." [Online], Available: http://www.oxfordreference.com/view/10.1093/acref/9780199237043.001.0001/acref-9780199237043-e-2469?rskey=iinMQJ&result=2, 2009 [Aug 20, 2016]
  2. 2.0 2.1 "A Dictionary of Economics" published Oxford University Press, 2013. Edited by John Black, Nigar Hashimzade, and Gareth Myles Online version accessed [August 17th, 2017].
  3. A. Goolsbee, S. Levitt and C. Syverson. Microeconomics. New York: Worth Publishers, 2013, pp. 262.
  4. 4.0 4.1 M. Parkin and R. Bade. Economics: Canada in the Global Environment. Toronto: Pearson, 2013, pp. 228.
  5. R. A. Brealey et al. Fundamentals of Corporate Finance. Toronto: McGraw-Hill Ryerson, 2012, pp. 544.

Authors and Editors

Lyndon G., Celeste Pomerantz, Jason Donev
Last updated: August 29, 2017
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