Agriculture Reference
In-Depth Information
Table 3.1
Susan Lambert's accounting and economic profi t
Typical Year
Bad Year
Item
Subtotal ($)
Total ($)
Subtotal ($)
Total ($)
Total revenues
335,000
320,000
Plants and materials
150,000
150,000
Labor
40,000
40,000
Utilities
25,000
25,000
Taxes and insurance
10,000
10,000
Draw of salary
35,000
35,000
Total explicit costs
260,000
260,000
Accounting profi t
75,000
60,000
Foregone interest
32,000
32,000
Unrealized rent
25,000
25,000
Foregone income
15,000
30,000
Total implicit costs
72,000
87,000
Economic profi t
3,000
(27,000)
Starting with her accounting profi t of $75,000, Susan must now consider the appropriate
implicit costs involved in her decision to operate her business. This requires determining
what alternative uses or opportunity costs there are for Susan's time, the cost of the building
provided by her parents, and her investment in the business.
One essential resource that she contributes to the fi rm is her own time and talent. Susan
fi gures that she could sell her business and go to work for someone else for a salary of
$50,000 annually, given her experience and contacts, or $15,000 more than she paid herself
last year. This opportunity cost takes into account Susan's time and management abilities.
Of course, some entrepreneurs place a non-monetary value on being their own boss. Second,
eventually she will have to pay the rental cost of the building. Either her parents will sell it
to someone else (who will expect $25,000 in rent) or she will inherit the property (and be
responsible for expenses or she could earn $25,000 by renting it to someone else). Finally,
Susan must consider the opportunity costs of her own investment of $400,000 in the busi-
ness. What are some alternative uses for this investment? Perhaps she could put it into a
mutual fund account earning an average of 8 percent or buy government bonds at 5 percent.
The opportunity costs would be 8 percent of $400,000 or $32,000 each year, because that is
the most profi table alternative use for Susan's money.
Thus, Susan's total implicit costs are $72,000 for foregone interest, unrealized rent, and
foregone income (
Table 3.1)
. Her economic profi t is $3,000, or the accounting profi t of
$75,000 less the implicit costs of $72,000. Her economic profi t represents the real fi nancial
reward that Susan received for risking her own resources in the business. As long as
this amount is positive, it suggests that the decision to commit resources to this business is a
good one. Given that she has been fully compensated for her time, the $3,000 of economic
profi t can be viewed as a reward over and above what she needs to receive to be in this
business.
But what happens when Susan has a bad year;
Table 3.1
now shows an accounting profi t
of only $60,000 and she is offered a job at Home Depot for $65,000? Economic profi t in
this situation becomes negative ($60,000 - $25,000 - $32,000 - $30,000 = -$27,000). This
indicates that, had it been pursued, the (lost) opportunity to invest her capital in mutual funds
