Economic Profits and Losses – Learn the Facts

If you are running a business, it is always imperative that you know how you’re business is faring against competitors and the entire market. Economic profits and losses are great indicators of how well your business is doing. They measure different factors such as your revenue alongside the cost of a business decision that you’re making.

Economic profits and losses are a complex subject that many business owners tend to avoid but can be highly advantageous if learned and applied correctly. Not only does this help you identify which areas in your business are generating profits and losses, but it also determines how your business will look in the next few months. We must learn how to determine these profits and losses so that our business stays afloat or become even more profitable.

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If you want to learn more about economic profits and losses, check out the article below.

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Understanding Economic Profits and Losses

Economic profits and losses are significant tools in analyzing how efficient and effective is your business.

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It helps you make a firm decision on how and where you want your business to go by making the most optimal choice that will maximize the value of your business in the market. Both profits and losses are measured in two which are explicit costs and opportunity costs.

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Explicit costs are the payments by the business to produce goods and services such as creating the product, worker wages, rent, materials, and other goods about the day-to-day procedures of the business.

Meanwhile, opportunity costs are the profits that a certain business misses out on when you pursue another venture or make a decision over another. It is therefore the missed potential for profit for your business.

Economic Profit vs Accounting Profit

There is a large debate about the similarities and differences between economic profit and accounting profit as they share almost the same concept. Accounting profit is the total money or profit that your business makes after paying all the costs such as taxes, wages, rent, materials, and many others.

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This is commonly seen in your income statement or financial report. The accounting profit shows how much money your business has earned from doing business with your customers.

Economic profit, on the other hand, is the money that your business makes after paying all of the costs that includes the costs of choosing one business option over the other. It considers what your business could have earned in profit if it used the resources differently.

The Importance of Economic Profit and Losses to Your Business

Learning about economic profits and losses is important for many reasons. The concept alone provides incentives for many business owners to create value in the business decisions that they make.

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It motivates business owners to improve and become creative with their products and services to gain as much profit as possible.

This also discourages many business owners from wasting their precious resources or engaging in inefficient and ineffective business practices. Learning more about economic profits and losses also helps signal whether a business decision is effective or ineffective or if it is profitable or not profitable for you.

It helps you learn from your mistakes and make better decisions the next time you encounter such an experience.

Measuring the Performance of Your Business

A lot of businessmen often want to learn how their business is doing so that they can gauge their resources and make better decisions to make a profit. Learning about economic profits and losses ensures that you direct the allocation of your resources to the right customers.

By learning and determining your target market, you get to allocate the right amount of resources and direct them to where it makes the most profit. This guides business owners to produce the goods and services that have the highest demand and the lowest cost possible.

Learning about this concept enables you to leave a certain market that is not creating any value for your business. These are also useful tools to gauge the performance of your business that helps you make a good decision.

Advantages of Economic Profit

One of the main reasons why you should understand and practice economic profit is that it measures the success of your business. Economic profit is a great way to determine how the business is doing better than it would have if it choose a certain option.

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Since it carefully weighs all the options, you can assess and make an informed decision on which path you want your business to go. Another advantage of economic profit is that it also measures efficiency while also accounting profitability of your business.

It shows how well your company is doing by using the resources and making decisions that maximize the value of your business in the market.

Lastly, it pictures the reality of your business thus giving a more grounded but sound decisions for the direction of your business.

Disadvantages of Economic Profit

While there are a lot of advantages to learning the economic profits and losses of your business, there are also downsides to it. It can be difficult to estimate the opportunity cost of a business option that was not pursued accurately.

This might lead to some inaccuracies in the report that you receive. Economic profit is mostly theoretical and is not primarily recorded or even taxed, unlike accounting profits. It is not regulated by any financial institutions as well.

Economic profit can also lead to inappropriate short-term decisions since it does not reflect the long-term viability or sustainability of the business decision since it is only applicable for only a year.

Conclusion

Businesses nowadays are highly competitive and it is always up to the business owner to learn how to compete without taking up too much resources. This is the reason why many business owners should learn more about economic profits and losses. It can help you become a more proficient and effective business owner thus allowing your business to sustain any crisis for a long period.