Accounting Profit versus Economic Profit

When you analyze the financial progress of a company, the simplest account of any business is to study the total revenue, cost and profit. Revenue is the total sum of money received for its production. Cost includes everything that contributed to produce them. Profit, then, equals total revenue subtract total cost.

 

What is it?

There is no satisfactory definition of the term profit. In simple terms, profit can be understood as all the revenue generated by an individual or company. Profit is the goal of any business. There is no business. There are two conceptions of profit, accounting profit and economic profit. Accounting profit is a cash concept. It means total revenue minus explicit costs—the difference between money brought in and money paid out. When calculating accounting profits, the things that are considered include leased assets, non-cash adjustments/transactions for depreciation, provisions, allowances and capitalizing development costs. Economic profit is total revenue minus total cost, including both explicit and implicit costs. The difference is important because even though a business pays income taxes based on its accounting profit, it’s economic success depends on its economic profit. When calculating economic profits, several things, like opportunity costs, residual value, inflation level changes, tax rates, and interest rates on cash flow, are considered.

 

Example

To better understand the difference between economic and accounting profit, assume the total revenue of X business is 400,000. The explicit cost (utility bill, interest payments, mortgage, raw material cost, transport, storage cost, packaging cost, labour cost and more) is 150,000. So, the accounting profit would 400,000 — 150,000 = 250, 000 (total revenue — total explicit costs) and the economic profits 400,000 — (150,000 + 200,000) (total revenue — (total explicit costs + total implicit costs)) is 50,000. The accounting profit is interested in earnings more than what is going on in the marketplace. In this case, X made 50,000 more than marketplace income, hence that is X’s economic profit. Accounting profits are simply what you take home after deducting your explicit costs from your company revenues.

 

Analysis

The accountant and economist think differently. The accountant would consider production costs and how they affect company’s profitability. They would consider themselves as a production cost. On the other hand, when an economist describes the costs, they are more interested in how the company has decided to run the business or why they decided to imply a strategy and what impact those strategies will have on the rest of the economy.

 

In conclusion, one is taking the opportunity cost into consideration and while the other is not. The analysis of economic and accounting profit will help organizations understand their performance, future implementations, profitability, risk, market position and financial stability. It would also help stakeholders take critical decision like where to invest or how to get good returns.

 

Priyanka  | DBPC Blog

Fraud Prevention

Fraud can be broken down into three categories; Asset Misappropriation – when a company’s resources such as funds are stolen or exploited before or after being recorded; Corruption – occurs when an individual uses their influence in business relations as an advantage. Lastly Financial Statement fraud – when an individual omits or inputs false information in a company’s financial reports.

One effective way to prevent fraud within a company is to know your staff. Employees are not the only ones who participate in fraudulent activity. Executives and even owners, partake. A solid and trustworthy staff will aid in the prevention of loss in supplies, products and/or funds. While some employees are faithful, hardworking and believe in helping a company reach its ultimate goals, there are still some employees who will engage in fraudulent activity. Having an open door policy where employees can comfortably report any suspicious activity without the fear of negative repercussion, as well as fraud awareness training, is also a valuable defense against fraud.

Implementing programs for the protection of the company’s assets guarantee the integrity of its accounting records. These programs should be consistently reviewed for effectiveness. Internal as well as external audits also an assist in fraud prevention. This could be done by frequently monitoring your business structure, employee behavior and information systems. Delegation of department to managers or supervisors makes it easier to screen the going-ons within a company.

Recruiting experts such as certified fraud examiners and certified public accountants can be very beneficial towards the fight against fraud. Their job is to provide a company with basic consultations as well as internal audits and financial forensic analysis. It is also possible for a supplier to “skim” items from a shipment without a company being aware. Therefore, regular revision of suppliers and screenings is also a good idea.

As horrible as it may sound, fraud happens within a company more often than you think. Whether it is a multi-million dollar company or a small start-up business, every company is susceptible. Implementing a solid policy and the proper procedures and protocols in place will minimize fraudulent activity.

Rickeshia P | DBPC Blog