Any company of any size, whether it is a blogger’s company of a sole proprietor or some more severe and complex corporation, needs to calculate accounting profit or loss. In layman’s terms, every company needs to be sure whether it makes money or loses money. This term is even better known as a profit or loss account that is applied anywhere in the world following the accounting policies and rules intended for that location and is interpreted depending on the situation. Today we present our calculator that can help you calculate your accounting profit or loss faster, and you can find out how it works below.
What is accounting profit?
To begin with, we need to explain the concept and meaning of accounting profit. It is a method of calculating profits using direct costs. As such, it represents the company’s net income and is calculated by subtracting the value of expenses from income, following the rules and norms of the Generally Accepted Accounting Principles, known by the abbreviation GAAP. The obtained financial results are presented in the financial statements. Accounting profit is used by management to assess the company’s performance and current financial position concerning its competitors while observing the entire industry in which the company operates. The notion of direct costs includes material, production, and overhead costs, as well as costs of labor, transport, sales, marketing, etc.
How to calculate accounting profit?
Understanding the accounting profit calculation is easiest to explain if we link the two basic definitions of profit relating to accounting and economic profit. Therefore, we can conclude that we calculate the accounting profit as the total realized money from sales or the total income obtained by multiplying the price by the sold quantity, which is further reduced by the total costs of production of goods. This difference between income and all the overhead costs distinguishes the concept of accounting and economic profit, which we will talk about later. Also, in calculating accounting profit, we can mention that the recommendation is to do it at least once a month, which will not show all the costs, such as the depreciation of fixed assets. That is why it is recommended to submit a report to accounting experts who will prepare in detail and give you a detailed explanation of the state of your business finances.
Accounting profit formula
As we have explained the calculation method, the next step will be to clarify the formula. Given the definition, we have concluded that the accounting profit is calculated by deducting from the total earnings all direct operating expenses. Accounting profit is very similar to profit, which represents the difference between all income and expenses.
When it comes to our accounting profit calculator, you can apply all these calculation concepts that we explained earlier. The calculator offers you the option to use and enter some of four different costs that together make direct costs. These groups include operating expenses, interest, depreciation, and taxes. Therefore, the accounting profit formula can also have this appearance:
Accounting \; Profit = TR - EC
TR– total revenue
EC – explicit costs
where ECs are counted as:
Total \; Explicit \; Costs = Operating \; Costs + Interest + \\ Depreciation + Taxes
What is the difference between accounting profit and economic profit?
From the previously explained, we could conclude what accounting profit means. In contrast, economic profit is a term very similar to accounting profit. Opportunity costs are used to calculate economic profit to take one action concerning another. Economic principles determine this type of profit as such. One of the fundamental differences is that economic profit uses implicit costs, more precisely, the company’s expenses. They refer to the market price at which a company can sell a particular natural resource. There are some fundamental differences between these two concepts, and we can point out that economic profit is a theoretical calculation based on alternative actions. In contrast, accounting profit provides measurable data of what happened.
Accounting vs. economic profit – an example
As we have explained the difference between these two terms, we can give an example from practice that will explain to you in more detail everything that has been said through definitions. Let’s take the situation that you had the opportunity to buy a new printer for $ 1,000, which would generate some value of $ 1,700 in revenue in the future. However, you have not opted for this option due to some current market circumstances. After some time, you become aware of the facts, and you conclude that you would deduct $ 700 from your earned income before tax, considering that the cost of not buying a machine is $ 700 of future revenue. To calculate the economic profit now, you need to consider other alternative actions that could have happened when making that decision. If we think of the accounting profit, in this case, you would not take into account opportunity costs but would perform the calculation procedure following measurable values.
Accounting profit is equal to?
Accounting profit is equal to the difference between total revenues and direct expenses. The value of accounting profit can be positive and, as such, is limited in time. It considers only the realized costs and revenues observed in one time period, whether on a quarterly or annual basis. The costs included in this calculation are the costs of labor, transportation, marketing, production, and the like.
If there are no implicit costs related to the company’s operations, then the value of the accounting profit will be equal to the economic profit. These cases are prevalent in practice, but they are not impossible.
Suppose the direct costs of production of goods or services at the end of the accounting period of the company’s operations are higher than the realized revenues. In that case, the value of the accounting profit will be negative. This tells us that a particular product is not operating profitably, and specific changes need to be made to save the business.