Economic profit is that part of the result of economic activity, expressed in monetary units, that could be withdrawn at the end of a period without reducing the capital required for success. In other words: the economic profit represents that part of the period result that can be extracted without jeopardizing the sustainability of the economic performance.
If funds in the amount of the accounting profit are repeatedly withdrawn from an economic entity, it can happen that the performance capacity diminishes in the course of time. The economic profit is used to determine how high withdrawals should be without reducing the productivity. In many cases, the economic profit is less than the book profit, and the difference is then referred to as the apparent profit.
The concept of economic profit is based on these findings:
1. Real capital is aging. It wears out over time and with use. The economic profit therefore requires a correct recording of the depreciation. The depreciation should relate to replacement values.
2. Real capital with a special function is subject to obsolescence, which means that it can go out of fashion economically even though it would still be physically functional. The possibility of achieving economic results with real capital thus depends on the environment and on the markets, and changes in the world can further devalue real capital. Obsolescence leads to a reduction in economic profit.
3. After all, success is in terms of money, but there is inflation in all currencies. It is therefore possible that the economic profit should be measured in such a way that the success is not only maintained in nominal terms but in real terms. To maintain real productivity, a certain nominal increase in capital is required to compensate for the inflation. Taxes that are payable on so-called fictitious profits may also have to be taken into account.
4. In a growing world it may be appropriate to speak of the sustainability of success only if success does not fall behind in relation to the rest of the business world. That calls for dynamization.
For the four reasons mentioned, the economic profit is less than the book profit. On the other hand, the profit of a company in accounting can already be diminished by the fact that various expense items have been deducted from the success, with which an increase in economic performance is more associated. Then it could be that the economic profit is greater than the book profit.
This includes one-off depreciation on purchased systems and equipment, which can nonetheless be used economically for several periods. In today's practice, probably the most important reason why the economic profit can be greater than the book profit is the fact that many companies spend (wages) on research and development and marketing without activating the work results. The creation of intellectual capital with its own research departments also leads to the formula:
Economic profit = profit + investment
In any case, the economic gain is not excess gain. In order to determine an excess profit based on the economic profit, one would have to subtract a profit (cost of capital) that is usually to be expected. This is what happens when calculating the economic value added:
EVA = Economic Profit - Cost of Capital
Although economic profit is the translation of “economic profit”, the terms are different. Economic profit is a variant of excess profit that is propagated by the consulting firm McKinsey & Company.
It is important that the economic gain presupposes an idea of what exactly should be understood by the maintenance of economic performance.
Wenn eine Family business, die heute 10% des Marktes von Wasserstoffpumpen bedient und als technologisch innovativ gilt, für die Berechtigten Familienmitglieder jedes Jahr 1 Million Euro abwerfen soll und dieser Betrag sich entsprechend der Geldentwertung im Laufe der Zeit erhöhen soll, dann ist das eine andere Vorstellung, als wenn die Leistungskraft als Erhalt des zehnprozentigen Marktanteils definiert wird. Eine dritte Vorstellung wäre die, daß die wirtschaftliche Leistungskraft erhalten bleibt, wenn die Unternehmung weiterhin ihre technologische Spitzenposition behält. Jede der drei Vorstellungen führt auf einen anderen ökonomischen Gewinn.
In 1990 the Stuttgart automobile company Daimler Benz (today DaimlerChrysler) commissioned a study to compare two concepts of the “right” return for shareholders.
Bei einem Konzept wurde gefragt, welche Rendite Aktionäre im Capital market mit einer anderen Aktie vergleichbaren Risikos erwarten können.
With the other concept, the aim was to offer the shareholders a dividend in the usual amount on the one hand and to allow the dividends to rise over the years, as has always been the case in the past. In addition, in a dynamic world, the company's economic and technological performance should be secured over the long term.
Both concepts lead to different “capital costs” and ultimately to different investment decisions.
It is worth noting a special idea of what it should mean to maintain performance. If this condition is understood as the preservation of the market value of the capital in nominal amount, then the economic profit corresponds to the product of the financial return and the capital employed.