Business Profit Profit generally is the making of gain in business activity for the benefit of the owners of the business. The word comes from Latin meaning "to make progress", is defined in two different ways, one for economics and one for accounting.Pure economic profit is the increase in wealth that an investor has from making an investment, taking into consideration all costs associated with that investment including the opportunity cost of capital. Accounting profit is the difference between retail sales price and the costs of acquisition whether by harvest, extraction, manufacture, or purchase. A key difficulty in measuring either definition of profit is in defining costs. Accounting profit may be positive even in competitive equilibrium when pure economic profits are zero. In economics, a firm is said to be making a normal profit when total revenues equal total costs. These normal profits then match the rate of return that is the minimum rate required by equity investors to maintain their present level of investment. Economically, the "normal profit" is thus treated as a cost, and recognized as one of the two components of the cost of capital.An economic profit arises when its revenue exceeds the total opportunity cost of its inputs, noting that these costs include the cost of equity capital that is met by "normal profits." A business is said to be making an accounting profit if its revenues exceed the accounting cost the firm "pays" for those inputs. Economics treats the normal profit as a cost, so when deducted from total accounting profit what is left is economic profit or economic loss. All enterprises can be stated in financial capital of the owners of the enterprise. The economic profit may include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise will succeed or not. This extra risk is included in the minimum rate of return that providers of financial capital require, and so is treated as still a cost within economics. The size of that return is commensurate with the riskiness associated with each type of investment, as per the risk-return spectrum."Normal profits" arise in circumstances of perfect competition when economic equilibrium is reached. At equilibrium, average cost = marginal cost at the profit-maximizing position. Since normal profit is economically a cost, there is no economic profit at equilibrium. In a single-goods case, a positive economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average cost and the price.onomic profit does not occur in perfect competition in long run equilibrium. Once risk is accounted for, long-lasting economic profit is thus viewed as the result of constant cost-cutting and performance improvement ahead of industry competitors, or an inefficiency caused by monopolies or some form of market failure.   Accounting definitions of profit In the accounting sense of the term, net profit before tax is the sales of the firm less costs such as wages, rent, fuel, raw materials, interest on loans and depreciation. Costs such as depreciation and amortization tend to be ambiguous. Within US business, the preferred term for profit tends to be the more ambiguous income.Gross profit is profit before Selling, General and Administrative costs SG&A, like depreciation and interest; it is the Sales less direct Cost of Goods or services Sold COGS,Net profit after tax is after the deduction of either corporate tax for a company or income tax for an individual.Operating profit is a measure of a company's earning power from ongoing operations, equal to earnings before the deduction of interest payments and income taxes. To accountants, economic profit, or EP, is a single-period metric to determine the value created by a company in one period - usually a year. It is the net profit after tax less the equity charge, a risk-weighted cost of capital. This is almost identical to the economist's definition of economic profit.There are commentators who see benefit in making adjustments to economic profit such as eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to show its value over multiple accounting periods. The underlying concept was first introduced by Schmalenbach, but the commercial application of the concept of adjusted economic profit was by Stern Stewart & Co. which has trade-marked their adjusted economic profit as EVA or Economic Value Added.Optimum Profit - This is the "right amount" of profit a business can achieve. In business, this figure takes account of marketing strategy, market position, and other methods of increasing returns above the competitive rate.Accounting profits should include economic profits, which are also called economic rents. For instance, a monopoly can have very high economic profits, and those profits might include a rent on some natural resource that firm owns, where hat resource cannot be easily duplicated by other firms.   Comprehensive income Comprehensive income is defined by the Financial Accounting Standards Board, or FASB, as “the change in equity net assets of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.” omprehensive income is the sum of net income and other items that must bypass the income statement because they have not been realized, including items like an unrealized holding gain or loss from available for sale securities and foreign currency translation gains or losses. These items are not part of net income, yet are important enough to be included in comprehensive income, giving the user a bigger, more comprehensive picture of the organization as a whole. Items included in comprehensive income, but not net income are reported under the accumulated other comprehensive income section of shareholder's equity. Comprehensive income or earnings attempts to measure the sum total of all operating and financial events that have changed the value of an owner's interest in a business. It is measured on a per-share basis to capture the effects of dilution and options. It cancels out the effects of Equity transactions for which the owner would be indifferent; issues of dividends; share buy-backs; share issues at market value.It is calculated by reconciling the the book-value-per-share from the start of the period to the end of the period. This is conceptually the same as measuring a child's growth by finding the difference between his height on each birthday. All other line items are calculated, and the equation solved for Comprehensive Earnings.   Economic surplus The term surplus is used in economics for several related quantities. The consumer surplus sometime named consumer's surplus or consumers' surplus is the amount that consumers benefit by being able to purchase a product for a price that is less than they would be willing to pay. The producer surplus is the amount that producers benefit by selling at a market price that is higher than they would be willing to sell for. Note that producer surplus flows through to the owners of the factors of production, unlike economic profit which is zero under perfect competition. If the markets for factors are perfectly competitive as well, producer surplus ultimately ends up as economic rent to the owners of scarce inputs such as land.On a standard supply and demand S&D diagram, consumer surplus CS is the triangular area above the price and below the demand curve, since intramarginal consumers are paying less for the item than the maximum that they would pay. In contrary, producer surplus PS is the triangular area below the price and above the supply curve, since that is the minimum that a producer can produce that quantity with. If the government intervenes by implementing, for example, a tax or a subsidy, then the graph of supply and demand becomes more complicated and will also include an area that represents government surplus.Combined, the consumer surplus, the producer surplus, and the government surplus if present make up the social surplus or the total surplus. Total surplus is the primary measure used in welfare economics to evaluate the efficiency of a proposed policy.A basic technique of bargaining for both parties is to pretend that their surplus is less than it really is: sellers may argue that the price they asks hardly leaves them any profit, while customers may play down how eager they are to have the article.In national accounts, operating surplus is roughly equal to distributed and undistributed pre-tax profit income, net of depreciation.In heterodox economics, the economic surplus denotes the total income which the ruling class derives from its ownership of scarce factors of production, which is either reinvested or spent on consumption.In Marxian economics, the term surplus may also refer to surplus value and surplus labour.   Distribution of benefits when price falls When supply of a good expands, the price falls assuming the demand curve is downward sloping and consumer surplus increases. This benefits two groups of people. Consumers who were already willing to buy at the initial price benefit from a price reduction, and additional consumers who were unwilling to buy at the initial price but will buy at the new price and also receive some consumer surplus.Consider an example of linear supply and demand curves. For an initial supply curve S, consumer surplus is the triangle above the line formed by price P to the demand line bounded on the left by the price axis and on the top by the demand line. If supply expands from S to S, the consumers' surplus expands to the triangle above P and below the demand line still bounded by the price axis. The change in consumer's surplus is difference in area between the two triangles, and that is the consumer welfare associated with expansion of supply. Some people were willing to pay the higher price P. When the price is reduced, their benefit is the area in the rectangle formed on the top by P, on the bottom by P, on the left by the price axis and on the right by line extending vertically upwards from Q.The second set of beneficiaries are new consumers, those who will pay the new lower price P but not the higher price P. Their additional consumption makes up the difference between Q and Q. Their consumer surplus is the triangle formed by on the left by the line extending vertically upwards from Q, on the right by the demand line, and on the bottom by the line extending horizontally to the right from P.   Economic value added Economic Value Added or EVA® is an estimate of true economic profit after making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital. GAAP is estimated to ignore US$3 billion in shareholder opportunity costs. EVA can be measured as Net Operating Profit After Taxesor NOPAT less the money cost of capital. Money cost of capital refers to the amount of money rather than the proportional rate cost of capital. The amortization of goodwill or capitalization of brand advertising and other similar adjustments are the translations that occur to Economic Profit to make it EVA. The EVA is a registered trademark by its developer, Stern Stewart & Co. In corporate finance, free cash flow FCF is a cash flow available for distribution among all the security holders of a company. They include equity holders, debt holders, preferred stock holders, convertibles holders, and so on.One of the primary objectives of accounting was to figure out what is the maximum amount of cash can you take out of the enterprise each period and still leave the business with the same productive resources going forward? Net income was roughly that measure. Free cash flow can be thought having a similar goal, how much “excess” cash can is spun out of an enterprise, after leaving enough cash in to maintain productive resources going forward?The second difference is that the Free Cash Flow measurement deducts increases in net working capital, where the net income approached does not. In a typically growing company with a 3 day collection period for receivables, a 3 day payment period for purchases, and a weekly payroll, it will require more and more working capital to financing the labor and profit components embedded in the growing receivables balance. The net income measure essentially says, “You can take that cash home” because you would still have the same productive capacity as you started with. The Free Cash Flow measurement however would say, “You can’t take that home” because you would cramp the enterprise from operating itself forward from there.   Problems with capital expenditures The expenditures for maintenance of assets is only part of the capex reported on the Statement of Cash Flows. It must be separated from the expenditures for growth purposes. This split is not a requirement under GAAP, and is not audited. Management is free to disclose maintenance capex or not. Therefore this input to the calculation of free cash flow may be subject to manipulation, or require estimation. Since it may be a large number, maintenance capex's uncertainty is the basis for some people's dismissal of 'free cash flow'.A second problem with the maintenance capex measurement is its intrinsic 'lumpiness'. By their nature, expenditures for capital assets that will last decades may be infrequent, but costly when they occur. 'Free cash flow', in turn, will be very different from year to year. No particular year will be a 'norm' that can be expected to be repeated. For companies that have stable capital expenditures, free cash flow will over the long term be roughly equal to earnings. Free cash flow measures the ease with which businesses can grow and pay dividends to shareholders. Even profitable businesses may have negative cash flows. Their requirement for increased financing will result in increased financing costs reducing future income.According to the discounted cash flow valuation model, the intrinsic value of a company is the present value of all future free cash flows, plus the cash proceeds from its eventual sale. The presumption is that the cash flows are used to pay dividends to the shareholders. Bear in mind the lumpiness discussed below.ome investors prefer using free cash flow instead of net income to measure a company's financial performance, because free cash flow is more difficult to manipulate than net income. The problems with this presumption are itemized at cash flow and return of capital.The payout ratio is a metric used to evaluate the sustainability of distributions from REITs, Oil and Gas Royalty Trusts, and Income Trust. The distributions are divided by the free cash flow. Distributions may include any of income, flowed-through capital gains or return of capital.   Owner earnings In 8, Warren Buffett detailed his valuation method. He stated that what he used to determine income was something called Owner Earnings. He defined owner earnings as follows: "These represent a reported earnings plus b depreciation, depletion, amortization, and certain other non-cash charges...less c the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume....Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since c must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes...All of this points up the absurdity of the 'cash flow' numbers that are often set forth in Wall Street reports. These numbers routinely include a plus b - but do not subtract c." Buffett's description of owner earnings is very similar to free cash flow.citation needed However, it should be noted that he averages capital expenditures over several years, rather than using a single year's value.citation needed Also, he is concerned with the capital expenditures necessary to maintain position, not expenditures used for growth.In finance, the discounted cash flow or DCF approach describes a method to value a project, company, or financial asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and incorporates judgments of the uncertainty riskiness of the future cash flows.Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management.