Profit

Profit is the amount by which a business's revenue exceeds its costs over a period. It is the reward to the owners who provide capital and bear risk, the main source of money for reinvestment and dividends, and the basis on which companies pay corporate tax. When costs exceed revenue, the result is a loss. Profits, also called earnings, are reported in the income statement, known under IFRS as the statement of profit or loss, and profits kept in the business add to retained earnings on the balance sheet.

Accountants and economists use the word differently. Accounting profit deducts the explicit costs a business pays, such as wages, materials, rent, interest and depreciation. Economic profit also deducts the opportunity cost of the owners' time and capital, so a business can show an accounting profit yet earn zero or negative economic profit. Profit is related to, but different from, cash flow: a company can be profitable on paper and still run out of cash. On the income statement, accounting profit left after interest and taxes is reported as net income, the bottom-line figure available for dividends or reinvestment.

A teenager runs a lemonade stand for a summer. Sales bring in $500, and lemons, sugar and cups cost $200, so the stand made $300. That is profit in the everyday sense.

An economist would ask one more question: what else could the teenager have done with that summer? If a part-time job would have paid $400, the stand actually left them $100 worse off. Both views are useful. The first tells the stand's owner how much money came in; the second tells them whether it was worth doing.

Companies report profit at several levels, each subtracting more costs:

• Gross profit. Revenue minus the cost of goods sold, showing how much is earned on what is sold before overheads.
• Operating profit. Gross profit minus operating expenses such as staff, marketing, rent and depreciation; it shows the profit from the core business. EBITDA is a related measure that adds back depreciation and amortization.
• Profit before tax. Operating profit after interest and other financial items.
• Net profit. What is left after tax, available to shareholders; divided by shares in issue it gives earnings per share.

From 2027, IFRS 18 will require companies using IFRS to show two defined subtotals, operating profit and profit before financing and income taxes, making profit figures more comparable across firms. Dividing each level by revenue gives the corresponding margin.

The difference can be written as:

• $\text{Explicit costs}$ are payments to others, the costs used in accounting profit.
• $\text{Implicit costs}$ are the opportunity costs of resources the owners supply themselves, including a normal return on their capital.

Worked example: a firm earns revenue of $1 million and pays explicit costs of $800,000, so accounting profit is $200,000. Its owners have $1.5 million invested that could earn 10% elsewhere, an implicit cost of $150,000, and the founder gives up a salary of $70,000. Economic profit is $1{,}000{,}000 - 800{,}000 - 150{,}000 - 70{,}000 = -20{,}000$ dollars, a small economic loss despite the accounting profit.

Economic profit of zero is called normal profit: the owners earn just enough to keep their resources in the business. Profits above that are supernormal profits.

Standard microeconomics assumes firms aim to maximize profit, which happens where marginal revenue equals marginal cost. In perfect competition, supernormal profits attract new entrants, so in the long run they are competed away to normal profit. In a monopoly or oligopoly, barriers to entry allow supernormal profits to persist, which is why persistent high profits can be a sign of market power and draw attention from competition authorities. Joseph Schumpeter saw temporary profits from innovation as the reward that drives entrepreneurs and creative destruction.

The role of profit is debated. Supporters of free markets regard it as the signal that directs resources to where they are most valued. In Marxist economics, profit comes from surplus value extracted from labor, a view based on the labor theory of value. Economists who study economic rent distinguish profit earned by creating value from returns secured by rent-seeking. The question of whether firms should focus on profit and shareholder value or balance wider interests is central to debates over stakeholder capitalism.

Investors value companies largely on expected future profits, using ratios such as the price-to-earnings ratio. Governments tax profits through corporate income tax and sometimes through a windfall tax on unexpected gains, as several European countries did on energy companies in 2022. In Islamic finance, returns are earned through profit-sharing contracts such as mudarabah rather than fixed interest. At the national level, statistical agencies measure corporate profits and the profit share of income, which macroeconomists watch as a sign of business health and of how income is split between capital and labor.

• IFRS Foundation: IFRS 18 Presentation and Disclosure in Financial Statements