How this calculator works
Economic profit subtracts two kinds of cost from revenue. Explicit costs are the payments a business makes: wages, rent, materials and interest. Implicit costs are the opportunities given up by running the business, such as the salary the owner could earn elsewhere, the rent the owner could collect by leasing the premises, and the return that could be earned on the capital invested. Accounting profit counts only explicit costs, so a business can report a comfortable accounting profit and still destroy value once implicit costs are included. Zero economic profit is normal in a competitive market and is called normal profit.
Formula
Economic profit = total revenue - explicit costs - implicit costs. Revenue = economic profit + explicit costs + implicit costs. Explicit costs = revenue - implicit costs - economic profit. Implicit costs = revenue - explicit costs - economic profit.
Worked example
Revenue of $500,000 with $400,000 of explicit costs and $150,000 of implicit costs gives an economic profit of -$50,000. The business pays its bills but earns less than the owner could earn elsewhere, even though accounting profit is $100,000.
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Frequently asked questions
Why is economic profit lower than accounting profit?
Economic profit deducts implicit costs, which accounting does not recognize because no payment changes hands. The gap is exactly the implicit cost figure.
What is normal profit?
Normal profit is zero economic profit: revenue exactly covers explicit and implicit costs. At that point the owner is earning the same as the next best alternative, so there is no incentive to enter or leave the industry.
How do I estimate implicit costs?
Use the market value of what the owner gives up: a competitive salary for the owner's time, market rent for owned premises, and a normal return on invested capital. Estimates are judgement calls, so state the assumptions alongside the result.