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  • Accounting Profit: What It Is, How to Calculate It, and Key Differences

Accounting Profit: What It Is, How to Calculate It, and Key Differences

By upGrad

Updated on Dec 24, 2024 | 7 min read | 1.5k views

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Imagine you run a bakery earning INR 1L in sales, with total costs (ingredients, rent, utilities, etc.) adding up to INR 70K. Your accounting profit is INR 30K—simple, right? 

But here’s the catch: Are you factoring in hidden costs like depreciation? Do you understand how accounting profit differs from economic profit or cash flow? And more importantly, are you using this data effectively to make strategic decisions?

Missteps can lead to flawed financial strategies or missed opportunities for growth. In this blog, you’ll dive into the details and uncover how accounting profit works, where it fits, and why it matters. Ready? Dive in!

What is Accounting Profit?

Accounting profit is the difference between a company’s total revenue and its explicit costs. It measures a business’s financial performance, excluding opportunity costs.

Here are the key elements of accounting profit:

  • Total Revenue: The total income generated from sales or services.
  • Explicit Costs: Direct costs such as wages, rent, raw materials, and utilities.

Role in Financial Statements

Accounting profit appears in the income statement and reflects a company's operational success. It’s used for assessing profitability, determining taxes, and making business decisions.

The following reasons are why it’s important:

  • It helps assess business viability and profitability.
  • It is used to determine taxes owed.
  • It serves as the basis for strategic decisions and planning.

If you want to build deeper expertise in evaluating the financial performance of a business, check out upGrad’s Financial Analysis Course.

Also Read: Tools of Financial Statement Analysis: Objectives, Techniques, Types

Understanding what is accounting profit isn’t enough; you also need to know how to calculate accounting profit accurately. Let’s break it down step-by-step.

How to Calculate Accounting Profit

Calculating accounting profit is straightforward. It involves subtracting explicit costs from total revenue. Follow these simple steps to calculate your business’s accounting profit.

Step 1: Determine Total Revenue

Total revenue is the total money earned from selling goods or services. This includes all income streams your business generates, such as:

  • Sales of products: INR 5L from selling handmade jewellery.
  • Service fees: INR 1.5L earned from custom design consultations.
  • Interest income: INR 20K from a fixed deposit account.
  • Any other income sources: INR 30K from renting out a small workspace.

Total Revenue Example: INR 7L for the month.

Also Read: Purpose of Financial Accounting: Function, Importance, Principles

Step 2: Identify Explicit Costs

Explicit costs are the direct, out-of-pocket expenses necessary to operate your business. These typically include:

  • Rent: INR 15K for the bakery space.
  • Salaries and Wages: INR 5K paid to part-time staff.
  • Raw Materials: INR 20K spent on flour, sugar, and other ingredients.
  • Utilities: INR 3K for electricity and water.
  • Equipment Maintenance: INR 2K for servicing ovens and mixers.

Example Total Explicit Costs: INR 45K for the month.

Step 3: Subtract Explicit Costs from Total Revenue

Now that you have both total revenue and explicit costs, subtract the total explicit costs from the total revenue to find your accounting profit.

This is called the accounting profit formula.

Accounting Profit Formula

You can use this formula to calculate accounting profit.

Accounting Profit = Total Revenue - Explicit Costs

Example:

  • Total Revenue: INR 60K
  • Explicit Costs: INR 40K
  • Accounting Profit = INR 60K - INR 40K = INR 20K

If you want to deepen your understanding of modern financial systems and stay ahead in your career, explore upGrad’s Introduction to Digital Banking Course. 

Also Read: Finance vs Accounting: Which One Should You Choose?

While accounting profit is crucial, it’s not the only measure of a company’s success. Comparing it to economic profit reveals a broader picture of profitability.

Accounting Profit vs. Economic Profit

While both accounting profit vs economic profit measure a company's financial success, they differ in how they account for costs. Understanding these differences between accounting profit vs economic profit is crucial for businesses and investors when making financial decisions.

Comparison Table: Accounting Profit vs. Economic Profit

Accounting profit vs economic profit have different criteria. To understand the differences between the two, refer this below table:

Criteria

Accounting Profit

Economic Profit

Definition Total revenue minus explicit costs. Total revenue minus both explicit and implicit costs.
Costs Considered Only explicit costs (e.g., wages, rent). Both explicit costs and implicit (opportunity) costs.
Purpose Measures financial performance for taxation and reporting. Provides a more comprehensive view of a company’s profitability, considering all resource usage.
Implication Tells whether a company is financially viable based on operational expenses. Tells whether a company is truly maximizing its resources and making the best decisions.
Example Revenue = INR 1L, Explicit Costs = INR 60K → Accounting Profit = INR 40K Revenue = INR 1L, Explicit Costs = INR 60K, Implicit Costs = INR 20K → Economic Profit = INR 20K

Also Read: Financial Accounting vs. Management Accounting: A Comprehensive Guide

Accounting Profit vs. Other Profit Metrics

To gain a well-rounded understanding of financial performance, it's important to compare accounting profit with other profit metrics. Each metric serves a different purpose in evaluating business health.

1. Accounting Profit vs. Underlying Profit

  • Accounting Profit: Focuses on actual cash flows and operational expenses.
  • Underlying Profit: Adjusted for non-recurring or unusual items to reflect a company’s ongoing performance.

2. Accounting Profit vs. Cash Profit

  • Accounting Profit: Based on accrual accounting, meaning it includes both cash and non-cash transactions (e.g., depreciation).
  • Cash Profit: Only considers cash inflows and outflows, ignoring non-cash items like depreciation.

3. Accounting Profit vs. Taxable Profit

  • Accounting Profit: Determined based on financial reporting standards and includes all explicit costs.
  • Taxable Profit: Adjusted for tax laws, deductions, and allowances, often making it different from accounting profit.

Also Read: Top 10 Skills Required for Finance and Accounting

Whether you’re a student, entrepreneur, or finance professional, mastering these concepts can boost your career. Here’s how upGrad can help you get there.

How upGrad Helps You Build Your Skills?

upGrad offers a comprehensive approach to help you build and refine your skills in accounting. Through their specialized programs, you can gain technical knowledge, hands-on experience, and 100+ free courses. Join over 1 million learners to build job-ready skills and tackle industry challenges.

Here are some relevant courses you can check out:

Course Title

Description

Master’s Degree in International Accounting and Finance Build a successful career in international accounting and finance with a PwC Academy certification.
Accounting Fundamentals Learn about financial statements, how to interpret them, and make business decisions based on financial data.
Professional Certificate Program in Financial Modelling and Analysis Transform your professional journey in finance with live training from PwC India and top finance experts. 
LL.M. in Corporate and Financial Law In-depth knowledge of corporate transactions, financial markets, and regulatory frameworks.

You can also get personalized career counseling with upGrad to shape your career, or visit your nearest upGrad center and start hands-on training today!

Frequently Asked Questions (FAQs)

1. What are examples of industries where accounting profit might differ significantly from economic profit?

2. How do implicit costs impact long-term business strategy compared to explicit costs?

3. Are there limitations to relying solely on accounting profit for decision-making?

4. Can a company have a positive accounting profit but be financially unstable?

5. How does accounting profit interact with depreciation methods like straight-line or declining balance?

6. What role does accounting profit play in investor relations and decision-making?

7. How is accounting profit used in mergers and acquisitions?

8. Why might accounting profit overestimate a company’s financial performance?

9.What adjustments can businesses make if their accounting profit consistently falls short of expectations?

10. How does inflation affect accounting profit calculations?

11. Can accounting profit be manipulated, and how can stakeholders detect this?

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