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Profit, Gross Profit And Net Profit

 Profit, Gross Profit and Net Profit

Gross Profit and Net Profit

            Profit is the surplus of income over expenses of production according to a businessman. It is the amount left with him after he has made payments for all factor services used by him in the process of production. But he may not have been careful in calculating all such expenses of production in the economic sense. Therefore economists regard business man’s profit as gross profit as distinct from net profits for the reason that it contains the following aspects.

  1. Rent on Land

    The business man may have used his own land for erecting the factory so that he may be protected of the inconvenience of paying rent to some other landlord. This rent is included in his profit. This is implicit or imputed rent which is not a part of his profit. Had he hire land from some other person, he would have paid its rent. In computing net profit, implicit rent must be deducted from gross profit.

  1. Interest on Capital

    Likewise, he may have used his own capital in his business in order to avoid the inconvenience of borrowing from some other person. This implicit interest is again included in his gross profit. If he had borrowed the same amount of capital for investment in his business, he would have paid interest on it. This implicit interest must therefore be deducted from his gross profit to arrive at net profit.

  1. Wages of Management

    The businessman may have been busy in organising, coordinating and managing the entire business himself. But he may have been contented with income received after meeting all expenses of production. If he had not performed the work of management himself, he would have employed a manager to whom he would have paid wages. Thus his gross profit included implicit wages which are required to be deducted for calculating net profit.

  1. Depreciation Charges

    During the process of production, machinery, and plants depreciate and become obsolete. Expenses incurred on their repairs and replacements are a part of the cost of production. Hence they must be excluded from gross profit for the purpose of computing net profit.

  1. Insurance Charges

    Every firm gets itself insured against fire, accidents and losses of other kinds for which it pays large premiums annually to insurance companies. They are a charge on the revenue of the firm and therefore do not form part of gross profit. All these elements are present in gross profit are due to the presence of net profit within the former. It is hence, net profit which may be positive or negative.

  1. Net Profit

    Net, true, economic or pure profit is the residue left to the entrepreneur after deducting all the items enumerated above from gross profit. Net profit, however includes the following elements within it.

  1. Reward for uncertainty Bearing
  2. Pure profit which an entrepreneur receives is the reward of bearing uninsurable risks and uncertainties. Uncertainty bearing is one of the main functions of an entrepreneur in the present capitalist system which leads to profit.

  3.  Reward for coordination
  4. The present system of production is one of coordinating the right quantity of factors in right proportions. An entrepreneur who combines them in the right way is able to produce larger quantities of the product with the minimum of cost and thus earns the largest amount of profit.

  5.   Rent of Ability
  6. Net profit accruing to the business man also includes the rent of his ability. An entrepreneur with superior business acumen is able to earn larger profits than the others.

  7.   Reward for innovation
  8. An entrepreneur who innovates by bringing out a new product or technique of production earns higher profit than others.

  9.  Monopoly Gains
  10. The modern market system is characterised by the existence of imperfect markets. Some of the shrewd entrepreneurs are able to push up their sales by making their products appear distinct and superior to others. In this process they also succeeded in raising the prices of their products. Thus their profits swell when they create semi monopolistic conditions for themselves.

  11.  Windfalls
  12. Pure profit earned by an entrepreneur may also include fortuitous or chance gain. The demand for his product may suddenly hike either due to the outbreak of war or as a result of the closing down of some of the other firms for some time on account of labour trouble. He therefore earns higher profit which is like a windfall.

    We may conclude that an economist’s profit is quite distinct from a businessman’s profit. The former is concerned with net profit which is arrived at by deducting from the businessman’s gross profit the remuneration for the latter’s own land, labour and capital.

    We may write in equation form:

    Gross Profit = Net Profit + (Implicit Rent + Implicit Interest + Implicit Wages + Depreciation and insurance charges).

    Net profit = Gross Profit – (Implicit Rent + Implicit Interest + Implicit Wages + Depreciation and insurance charges).

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