What is profit? Difference between net and gross profit

Profit is the reward of the entrepreneur. It is the return on the fourth agent of production viz enterprise. Actually what people call profit is not wholly a reward for then entrepreneurial function i.e. they do not get the whole of it as entrepreneurs but they get a part of it in the capacity of land lord, a capitalist or a manager. What people ordinarily call profit is really gross profit. In order to find pure or net profit many deductions will have to be made out of it.

Gross profit = Total receipts – Total costs

Gross profit is distinguished from net profit is the reward which goes to the owner of the industry for entrepreneurial work. This reward includes the payment for risk-taking, management of business and the control of the industry due to the special business ability of the entrepreneur. Net or pure profit is only one of the element of gross profit. The chief constituents of gross profit are as follows.

1)         Reward for other factors supplied by the entrepreneur:

There are many business in which the entrepreneur contributes the factors of production himself. He may produce a part or whole of the land or capital or he may himself work as a manager. If an entrepreneur has invested his own capital in business, than he must add in the total costs of production of an amount which he would have earned if capital had been loaned to another concern. So is also the case with the factory premises owned by entrepreneur himself. If owner of the business assumes the function of entrepreneur himself, than he must include his remuneration in the cost of production and this must be equal to the amount which would have obtained if he had worked in some other concern. All these costs are in fact a part of the normal costs of production. So while finding out net profit of the firm, these costs are to be deduced from the gross profit of the firm.

2)         Depreciation and Maintenance charges:

When a business is set up, a certain amount of fixed capital in the form of machinery and building etc has to be invested. During the process of production, this fixed capital does not remain in its original condition. It wears out with use. A wise entrepreneur has to set aside a part of his income for repairs, depreciation and renewals of worn out, obsolete machinery so that the capital should remain intact. While calculating the expenses of the business these costs should form a part of normal cost of production.

3)         Monopoly gains:

If a businessman is a sole producer of a particular commodity, then he can charge higher prices for his product from the consumers then what he can get in a competitive market. The total profit which a monopolist has thus earned is not due to his extra-ordinary ability but parts of it are due to his monopolistic position. So while ascertaining the net profit, the gain arising out of monopoly must be deducted from gross profit.

4)         Special gains:

Special gains are those gains which arise not due to special foresight or ability of businessman but because he has acquired, copyrights or patent etc from the state. The profit which occurs due to these advantages to the businessman should be excluded from the gross profit while estimating the net profit.

5)         Chance gains:

Some time it so happens that entrepreneur earns an unexpected gain from the stock of the commodity which he possesses. For instance if all of a sudden war breaks out in a country, the prices of essential goods all at once go up. The businessman who has a stock of these goods will earn abnormal profit. While arriving at net profits, these chance gains are to be deducted from gross profits.

6)         Net profit:

Net profit as we have stated earlier, is the reward of the entrepreneur work. If we make allowances from the gross profit for above five items, we are left with net profit. Net profit is thus only a part of gross profit, which goes to the entrepreneur for risk-taking, coordinating and organizing the business.