What's the difference between Accounting Profit and Economic Profit
Good question,
Accounting Profit is what we record as a profit (that is revenue minus expenses) of an enterprise or company activity.
Economic Profit takes this one step further and accounts for the opportunity cost of the enterprise or company activity.
At first glance this does not make much sense, here is an example.
You are an aspiring entrepreneur in the glass window business. You set up shop (lets say you put $800,000 capital into the business for floor space, labor and what-have-you) and start building your clientele and begin conducting business. At year end, you generated revenues of $100,000 and incurred total expenses of $87,000, your accounting profit would be the difference (total revenues - total expenses), in this case $13,000 (technically you would also be taxed, and there is most likely a cost of capital but I will leave this out of the example).
During that year you generated $13,000 in accounting profit.
Economic profit takes this one step further. Assume you also had a choice to set up a hardware shop with your $800,000 capital that you would have used to set up the window business.
This is where things get technical since it is hard to measure “ifs” and “buts” but assuming you did some research on the market you would learn that during the year, beginning hardware stores received a net return on equity of let us say 1.5% (average).
1.5% of $800,000 would be $12,000.
Your Economic profit would therefore be $13,000 - $12,000 = $1,000
By investing your money in the glass window shop instead of the hardware store, for that year, you generated greater profit.
