Economic profit (or loss) is a measure of a company’s performance that goes beyond accounting profit. It considers both explicit and implicit costs and is used to assess whether a business is generating returns that exceed the opportunity cost of the resources used. Unlike accounting profit, economic profit includes the concept of opportunity cost, which is the value of the next best alternative foregone.

The formula for economic profit is:

\[ \text{Economic Profit} = \text{Total Revenue} – (\text{Explicit Costs} + \text{Implicit Costs}) \]

Here are the key components:

1. **Total Revenue:**
– This is the total income generated by a company from its sales of goods and services.

2. **Explicit Costs:**
– Explicit costs are the direct, out-of-pocket expenses incurred by a company in its operations. These include costs such as wages, rent, raw materials, and other expenses that are recorded in the financial statements.

3. **Implicit Costs:**
– Implicit costs are the opportunity costs associated with using resources that the business already owns. These costs are not recorded in the financial statements but are considered in economic profit calculations. Implicit costs represent the value of resources in their next best alternative use.

The interpretation of economic profit can be as follows:

– If economic profit is positive, the business is earning returns that exceed both explicit and implicit costs. This suggests that the business is doing better than the next best alternative use of its resources.

– If economic profit is zero, the business is just covering all of its explicit and implicit costs. In this case, the business is earning a normal rate of return, and there is no economic profit.

– If economic profit is negative (economic loss), it indicates that the business is not covering all of its costs, including the opportunity costs of using its resources. This suggests that the business may be better off allocating its resources elsewhere.

It’s important to note that economic profit is a more comprehensive measure than accounting profit because it considers the full cost of resources, including the implicit costs that are often overlooked in traditional accounting. However, calculating implicit costs can be subjective, as it involves estimating the value of resources in their next best alternative use.

Economic profit is a useful tool for businesses and investors to assess the true economic performance of a company and make decisions about resource allocation and strategic planning. It helps in understanding whether a business is truly creating value above and beyond the costs incurred.