The income statement is a valuable indicator of how a company has performed for a period. Investors use it to determine whether a company has been profitable during that period. However, it reports the accounting profits only. While these profits are highly crucial, investors can also use other types of profits for their analysis. Before discussing those types, it is critical to define accounting profit.
What is Accounting Profit?
Accounting profit refers to a company’s net income determined through accounting practices. It involves deducting all expenses incurred from revenues for a specific period. On top of that, it may also include other income that companies have generated during that time. However, companies determine these figures through accounting policies, standards, and practices.
The accounting profit of a company is a part of its income statement. Since it gets impacted by accounting policies, it may differ from one company to another. On top of that, it may vary between companies using IFRS and GAAP. One of the most critical aspects of this type of profit is its association with accounting practices. On top of that, it also primarily involves accounting for explicit expenses only.
How to calculate the Accounting Profit?
Calculating accounting profits is straightforward. It involves deducting all expenses incurred during a fiscal period from the income generated. However, it only includes explicit expenses for that period. Therefore, the formula for accounting profit is as follows.
Accounting profit = Revenues (and other income) – Explicit costs
Explicit expenses include any items that companies can measure and identify. Usually, they also follow accounting practices and principles. These differ from implicit expenses. These factors also impact the other types of profits that investors may calculate.
What are the other types of Profits?
Apart from accounting profits, investors may also calculate other types of profits. Some of these include the following.
Economic profit
Economic profit determines a company’s net income while accounting for alternative use of its resources. It involves deducting explicit and implicit costs from the total revenues generated for a period. Implicit costs do not occur due to the exchange of resources. Therefore, companies do not record these. However, they still play a role in calculating economic profits.
The formula for economic profit is as follows.
Economic profit = Revenues (and other income) – (Explicit costs + Implicit costs)
Cash profit
One of the primary factors impacting the accounting profit is the accrual concept. Under this concept, companies record expenses when they occur rather than when paying for those expenses. However, cash profit only records expenses where cash payment has occurred. On top of that, it also considers revenues for which companies have received a settlement.
The formula for cash profit is as below.
Cash profit = Cash income – Cash expenses
Taxable profit
While accounting profit follows accounting conventions, taxable profit only considers tax rules. Usually, this type of profit only applies when calculating the tax payable at the end of each accounting period. Under tax rules, some accounting items may not be allowable income or expenses. After adjusting for those items, companies can reach the taxable profit.
Overall, the formula for taxable profit is as below.
Taxable profit = Taxable income – Allowed deductions/adjustments
Conclusion
Accounting profit refers to net income after deducting explicit expenses from revenues and other income. However, this profit only follows accounting rules and regulations. Investors may also calculate other types of profits, including economic, cash, and taxable profits. Each of these differs from accounting profits in the ways stated above.
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