Entrepreneurial Finance: Fundamentals of Financial Planning and Management for Small Business

CHAPTER 8 PROFIT AND THE COST–VOLUME ANALYSIS

8.1 Profit Concept Between Economics and Accounting

There is no doubt that “profit” is the most common and widely used term in the business world. However, the commonality and popularity of the term does not necessarily make it a clear concept with an unequivocal connotation. When the classical economics specified the four major factors of production as land, labor, capital, and entrepreneurial management, it also specified the payments these factors get for their individual contribution in the production process. These payments are respectively: rent, wages, interest, and profit. From here we can conclude that profit is the monetary return to those who initiate and manage the entrepreneurial function of production. If the first three payments (rent, wages, and interests) are made out of the product's sale revenue, the residual, if any, would constitute the fourth payment to the entrepreneur or owner as profit. It is in this sense we get the equality between profit and the net revenue since what we call profit is in fact the surplus over and above the costs of production. These costs may also include taxes, financing cost, and the like. Technically, profit would equal the difference between the total cost of production (TC) and the total revenue brought by the sale of products (TR).

It is worthwhile to note here that while the term ...