What is Gross Profit?
Gross profit, in ordinary language is the surplus of total expenditure of the firm. If you refer gross profit anywhere, you actually mean the Gross Profit. If we analyze the term “gross profit” it actually includes various items which are not profits in the strict sense. Various items included in Gross profit are briefly explained below.
Items included in Gross Profit
Gross profits is a term in which the following items are included in addition to the net profit due to the entrepreneur.
1. Remuneration for factors of production contributed by the entrepreneur himself
In many business enterprises the entrepreneur contributes his own capital or land and works as manager. In such cases the rent, interest and wages accruing to the entrepreneur will be included in the gross profit.
2. Depreciation and maintenance Charges
The entrepreneur has to deduct the amount towards depreciation undergone by machinery and plants to arrive at net profits. Depreciation is an item of expenditure, undergone in the process of production. Further expenditure towards insurance charges should have to be subtracted from the gross profit to find out net profit.
3. Extra-personal profit
In the course of the business, there are many extra gains to the entrepreneur. The exogenous factors would help the producer to get windfall incomes, monopoly gains and anticipated incomes.
It is possible for the entrepreneur to earn monopoly profits. This profit is not due to his ability but on account of his situation in the market. Similarly a sudden increase in price of the commodity due to external causes like war, the producer would get windfall incomes.
The existing stock would get appreciated and he would be making a profit. These are all chance profits and these have to be deducted from the gross profit to arrive at net profits.
4. Net profit
Of course net profit is one of the many items, but a very important one, included in the gross profit. The balance which remains after deducting the above stated items, we get net profits.
What is Net Profit?
Net profit is the exclusive reward for the entrepreneur. The following functions performed by the entrepreneur.
1. Reward for coordination
It is because of him the productive unit comes into being. He bears the brunt of coordinating the factors of production, draws up the plan of the business and gives full shape. For this he is remunerated.
2. Reward for risk-taking
In addition to co-ordination, the entrepreneur undertakes the risks of the business. He estimates costs and revenues and if anything goes wrong, he will be the ultimate bearer of loss.
3. Reward for innovation
The entrepreneur may originate new technicalities and techniques in his business, reduce the cost of production and earn lot of huge profits for himself.
Thus we find net profit is only one of the constituents of gross profit. It is arrived at by deducting all the contractual and non-contractual payment from gross profit. It should be remembered that the net profits may be either positive or negative.
If total expenditure (explicit and implicit) exceeds the total receipts, the net profits will become negative. This is the only case where the factor reward will be negative. Reward for other factors, will always be positive.