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Maximizing profit is one of the main goals of any business,
and measuring profit is essential in assessing the financial health and
performance of a company. However, the concept of profit goes beyond just
subtracting costs from revenues. There are different types of costs, and it
is important to consider them all to get a true picture of a company's
economic success.
Explicit costs are the direct costs that can be measured and expressed in
monetary terms. These costs include items such as wages, rent, and utility
costs. Implicit costs, on the other hand, refer to the opportunity cost of
choosing one way to utilize a firm's resources over another. These costs are
harder to measure as they are not reflected in a company's accounting
records. They include items such as the cost of forgoing a more profitable
opportunity or the cost of investing in one area of the company over
another.
Economists distinguish between accounting and economic profit based on what
costs are subtracted from revenues. Accounting profit is measured by
subtracting explicit costs from revenues, while economic profit is the
difference between a company's total revenues and both explicit and implicit
costs. Measuring economic profit is important as it provides a more accurate
picture of a company's profitability and economic success.
Calculating economic profit can be done in two ways. The first is by
subtracting explicit and implicit costs from revenues. This provides a more
comprehensive view of a company's financial performance. The second method
is to calculate the economic value added (EVA) indicator. EVA takes into
account the cost of capital and is calculated by multiplying the capital
invested by the weighted average cost of capital and subtracting this
product from the net operating profit after tax.
EVA is an essential tool for assessing the financial performance of a
company as it allows for a comparison of different companies and helps
investors and entrepreneurs decide which firms to invest in. By using EVA,
investors can assess how effectively a company is using its assets and
contributing to a long-term increase in shareholders' wealth.
In conclusion, profit is not simply the difference between revenues and
explicit costs. Implicit costs, such as opportunity costs, must also be
considered to get a more comprehensive view of a company's financial
performance. Measuring economic profit is important as it provides an
accurate picture of a company's economic success. Calculating economic
profit can be done in two ways, by subtracting both explicit and implicit
costs from revenues or by using the EVA indicator. EVA is an essential tool
for investors and entrepreneurs to assess a company's financial performance
and to make informed decisions about where to invest their money. |
