Accounting profit in one line
Accounting profit equals revenue minus explicit costs such as wages, rent, materials, interest and taxes.
This is the number on your income statement. It follows accounting rules, includes only costs that involved a payment or a recorded expense and is what you report to the IRS and lenders.
If you want to review how those statements fit together, read income statement vs. balance sheet.
Economic profit adds hidden costs
Economic profit subtracts both explicit costs and implicit costs, such as the salary you could earn elsewhere and the return your invested money could earn.
Implicit costs are real but do not appear as bills. Two common ones:
- Your time. If you could earn $80,000 working for someone else, that is a cost of running your own company.
- Your capital. Money tied up in the business could earn a return elsewhere.
Economic profit asks whether the business beats the best alternative, not just whether it makes money.
A worked example
A shop with a $60,000 accounting profit can have a negative economic profit if the owner could earn more elsewhere.
| Line | Amount |
|---|---|
| Revenue | $500,000 |
| Explicit costs (all bills) | ($440,000) |
| Accounting profit | $60,000 |
| Owner could earn elsewhere | ($75,000) |
| Return on $100,000 invested, at 6% | ($6,000) |
| Economic profit | ($21,000) |
The owner earns a profit on paper but is $21,000 worse off than the alternative. That may be acceptable for lifestyle reasons, and it is still worth knowing.
Why owners should look at both
Accounting profit keeps you legal and creditworthy. Economic profit guides big choices such as expanding, hiring or selling.
Use accounting profit to pay taxes, manage cash and qualify for funding. Use economic thinking to decide:
- Whether to keep investing in a weak line of business
- Whether to hire or do the work yourself
- Whether a new project beats simply paying down debt
- Whether selling would leave you better off
For related concepts see revenue and profit and calculating net profit.
You do not need a spreadsheet full of theory to use this. Once a year, write down what you could earn working for someone else, and compare it with what you take from the business in pay plus profit. If the business pays you meaningfully less, ask what has to change in pricing, costs or volume for the gap to close.
Profit is not cash
Both profit measures differ from cash in the bank. Timing of receivables, inventory and loan principal can leave a profitable business short.
A profitable month can end with less cash if customers pay late or you buy inventory ahead of sales. Principal payments on a loan are also not expenses, but they use cash. This gap is why many owners get surprised.
Read cash flow vs. profit and keep a rolling forecast. Our guide to why to create a cash flow projection shows how.
Using economic thinking to decide on funding
Borrow when the added profit exceeds the full cost of funding and the return you could get from the alternatives.
Illustrative example: a $40,000 funding offer costs $6,000. It will add $18,000 of gross profit over a year. The net gain is $12,000 before taxes, which beats leaving the project undone. If the same $40,000 of effort could earn more elsewhere, compare the two.
ROI Funder uses this payback-first view. We consider businesses with 500+ FICO, 6+ months in operation and $20,000+ monthly revenue, and we show true cost before you sign. See how to calculate small business loan ROI and working capital.
Frequently asked questions
Which profit appears on tax returns?
Accounting profit, based on recorded revenue and deductible expenses. Economic profit is an analytical tool, not a reported figure.
Can economic profit be negative while accounting profit is positive?
Yes. That happens when the profit is smaller than what your time and capital could earn elsewhere.
What is opportunity cost?
It is the value of the next-best alternative you give up when you make a choice.
Do lenders look at economic profit?
No. Funders typically focus on revenue, bank activity and cash flow, which come from accounting records.