In ordinary language, the term profit is used in the sense of gross profit. It is the difference between the total receipts or income of an entrepreneur and his expenditure or total explicit cost.
Some people call it as the difference between total revenue and the total contractual cost. Explicit costs are those costs which can be calculated by an accountant. That is why it is also called the accounting cost.
Gross profits are the difference between total revenue and total explicit cost. Gross profit = Total Revenue – Explicit cost
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To illustrate suppose a producer produces bicycles. Each bicycle sells at Rs. 2000/- and he produces 100 bicycles. His total revenue will be Rs. 2000 x 100 = Rs. 2 lakhs.
For producing bicycle the producer bring raw materials, pays interest on borrowed capital, rent of the building and wages and salaries to labourers. Suppose all these costs amount to Rs. 1 lakh.
So, gross profit will be 2 lakh – 1 lakh = 1 lakh.
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Gross Profit consists of the following elements.
(1) Implicit Cost:
Sometimes the entrepreneur contributes his own capital, own building to the business. He may be the owner of the business premises and he may be also working as the manager of his concern.
Had he not been the entrepreneur, he would have interest on his capital, rent for his buildings and some salary as a manager of some other concern. He has lost these incomes when he himself becomes the entrepreneur. All these constitute the implicit cost.
(2) Depreciation Cost:
The depreciation undergone by plant and machinery during the course of production is an item of expenditure which are included in gross profit.
(3) Tax:
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As we know, the Govt. imposes some taxes on the profit of the business concerns. The amount of tax paid must be deducted from gross profit to arrive at the net profit.
From the gross profit, when above three elements an deducted, what we get is net profit. Net profit is a pure profit. It is part of gross profit.
Net Profit = Gross Profit – Implicit Cost or Net Profit = Total Revenue – (Explicit Costs + Implicit Costs) Economists generally emphasis on Net profit. Because, it is a pure profit which is a reward for entrepreneurial functions like, efficiency in organisation of business Risk-bearing function and (iii) Innovation.