To calculate accounting profit and economic profit, start with your total revenue, subtract every explicit cost you actually paid to arrive at accounting profit, then subtract your implicit costs (the value of resources you used without writing a check) to arrive at economic profit. Accounting profit is the number that lands on your income statement. Economic profit tells you whether running the business beats what your time, property, and capital could earn somewhere else. A business can post a strong accounting profit and still lose ground economically once those hidden costs come into view.
The Two Formulas
Both calculations share the same starting point, and one feeds the other.
- Accounting profit = Total Revenue − Explicit Costs
- Economic profit = Total Revenue − Explicit Costs − Implicit Costs (equivalent to Accounting Profit − Implicit Costs)
Explicit costs are anything you paid money for: wages, rent, materials, utilities, loan interest. Implicit costs are the value of resources you used without a cash outlay, like your own labor or the rent you could have collected on a building you own. Every step below fills in one part of these formulas.
Step One: Add Up Total Revenue
Total revenue is every dollar the business brought in during the period, before any subtraction. For a sole proprietor, this number goes on Line 1 of IRS Schedule C as gross receipts.1Internal Revenue Service. 2025 Schedule C (Form 1040) – Profit or Loss From Business Corporations report the equivalent figure at the top of their income statements.
Pull every document that shows money coming in: sales receipts, invoices, deposit slips, credit card processing statements, and any Forms 1099 you received.2Internal Revenue Service. Publication 583 (12/2024), Starting a Business and Keeping Records You want one airtight gross receipts figure covering all income sources before deductions.
Step Two: Total Your Explicit Costs
Explicit costs are every verifiable expense the business paid during the period. They appear on bank statements, in your general ledger, and on your tax filings. The common categories:
- Payroll and employment taxes: wages plus your share of FICA and unemployment.
- Rent and occupancy: lease payments on office, retail, or warehouse space.
- Materials and inventory: raw materials, wholesale goods, and supplies consumed in production.
- Utilities and services: electricity, internet, phone, insurance premiums, and professional fees for accounting or legal work.
- Loan interest: interest paid on business debt (not principal, which is a balance sheet item).
- Depreciation and amortization: the annual allocation for equipment, vehicles, buildings, and intangible assets that lose value over time.
Keep the supporting paper for each one. The IRS expects records that show the amount and source of every deduction.3Internal Revenue Service. What Kind of Records Should I Keep Sloppy cost tracking distorts accounting profit, which then distorts the economic profit built on top of it.
Depreciation Is a Cost With No Cash Payment
Depreciation reduces accounting profit even though no money leaves your account during the period. Buy a $50,000 delivery truck and you don’t expense $50,000 in year one under standard rules. You spread the cost across the asset’s useful life. For tax purposes, the IRS uses the Modified Accelerated Cost Recovery System (MACRS), which assigns recovery periods by property type: five years for vehicles and computers, seven years for office furniture, up to 39 years for commercial buildings.4Internal Revenue Service. 2025 Publication 946
Method also matters. Straight-line depreciation spreads the cost evenly. Accelerated methods like 200% declining balance front-load bigger deductions into early years, cutting accounting profit more up front and less later.4Internal Revenue Service. 2025 Publication 946 Intangibles with a finite useful life, such as patents or software licenses, are amortized rather than depreciated, but the effect on profit is the same: a non-cash expense that lowers the bottom line.
Inventory Valuation Shifts Your Cost of Goods Sold
If you sell physical products, the inventory method you use directly changes cost of goods sold and therefore accounting profit. FIFO (first-in, first-out) assigns older, cheaper costs to goods sold during a period of rising purchase prices, which lowers cost of goods sold and lifts profit. LIFO (last-in, first-out) does the opposite: it assigns the newest, most expensive costs first, raising cost of goods sold and lowering profit.
The gap can run into thousands of dollars on identical sales. If you use LIFO for tax purposes, the IRS also requires you to use LIFO in reports to shareholders and creditors.5Internal Revenue Service. Practice Unit – Adopting LIFO Whichever method you pick, apply it consistently year over year.
Step Three: Do the Accounting Profit Math
Take a small retail shop with $500,000 in revenue for the year. Explicit costs break down as follows:
- Cost of goods sold: $180,000
- Payroll and employment taxes: $85,000
- Rent: $36,000
- Utilities and insurance: $14,000
- Depreciation: $12,000
- Loan interest and other expenses: $23,000
Total explicit costs: $350,000. Revenue of $500,000 minus $350,000 leaves an accounting profit of $150,000. That’s the figure on the income statement. It confirms the business made money in a bookkeeping sense. It says nothing about whether running the shop was the best use of the owner’s time and capital.
Step Four: Estimate Your Implicit Costs
Implicit costs are the value of everything you put into the business without getting paid for it. They never touch your books, which is exactly why economic profit exists as a separate measure. You have to estimate them, and the estimates have to come from real market data rather than gut feel.
Forgone Salary
If you work in your own business without drawing a market-rate salary, the gap between what you take and what someone else would pay you for similar work is an implicit cost. The Bureau of Labor Statistics publishes median wages by occupation, which is a reasonable starting point.6U.S. Bureau of Labor Statistics. Occupational Outlook Handbook – Occupation Finder If comparable management roles in your industry pay a median of $72,000 and you take no salary, your implicit labor cost is $72,000. If you pay yourself $40,000, the implicit cost is the $32,000 shortfall.
Property You Own and Use
When the business operates out of space you own, no rent expense appears in the books. But you could lease that space to someone else, so the implicit cost is the fair market rent for comparable commercial space nearby. If similar storefronts rent for $3,000 a month, the annual implicit cost is $36,000. For home-based work, the IRS simplified home office method values a dedicated workspace at $5 per square foot up to 300 square feet, capped at $1,500 a year.7Internal Revenue Service. Simplified Option for Home Office Deduction That figure addresses the tax deduction. For economic profit, use the actual rental market value of the space.
Opportunity Cost of Invested Capital
Money you put into the business could have been invested elsewhere. The opportunity cost is the return that capital would earn in a low-risk alternative. Treasury securities are the standard benchmark. As of February 2026, average interest rates on marketable Treasury bonds were roughly 3.4%, with Treasury notes near 3.2%.8U.S. Treasury Fiscal Data. Average Interest Rates on U.S. Treasury Securities If you have $200,000 of your own capital in the business, the implicit cost of that capital is roughly $6,400 to $6,800 a year. Some owners use a higher rate reflecting personal risk tolerance or expected returns on a diversified portfolio, but Treasury rates set the floor.
Step Five: Do the Economic Profit Math
Continuing the retail shop example, add the implicit costs:
- Forgone salary: $72,000
- Forgone rent on owned property: $36,000
- Opportunity cost on $200,000 of invested capital: $6,800
Total implicit costs: $114,800. Subtract that from the $150,000 accounting profit and economic profit comes to $35,200. This owner is genuinely ahead. The business returns more than the owner’s time, property, and capital would earn in their next best use.
Change the inputs and the picture shifts fast. If the owner’s alternative salary were $95,000 and the property could rent for $48,000, implicit costs would climb to $149,800 and economic profit would shrink to $200. Accounting profit is unchanged at $150,000. Economically, the owner is barely breaking even.
Reading the Result
Economic profit falls into three ranges, and each one points to a different decision.
Positive economic profit means the business earns more than everything you’re giving up to run it. Reinvesting, expanding, or simply staying the course all make sense. No alternative use of your resources would pay better.
Zero economic profit, sometimes called normal profit, means revenue exactly covers explicit and implicit costs. The label sounds worse than the reality. You’re still earning what you would earn elsewhere, and your capital is still getting a competitive return. The business isn’t underperforming your alternatives, it just isn’t outperforming them either.
Negative economic profit is the warning result. If implicit costs exceed accounting profit, you would be financially better off closing, taking a job, and investing your capital elsewhere. People run businesses for reasons beyond financial return, so this doesn’t automatically mean quit. It does mean you should know the true cost of staying.
Accounting Profit Is Not the Same as Taxable Income
One quick boundary worth stating, because it trips owners up: the accounting profit you just calculated is not the income figure the IRS taxes. Federal law requires taxable income to be computed using the same general accounting method you use for your books, whether cash, accrual, or another approved method.9Office of the Law Revision Counsel. 26 U.S. Code 446 – General Rule for Methods of Accounting Within that framework, specific rules push the two numbers apart. Section 179 lets you deduct the full cost of qualifying equipment in the year you buy it, up to $2,560,000 for 2026, even though your books spread the cost over several years.10Internal Revenue Service. Instructions for Form 4562 (2025) Business meals show up in full on your books but are generally only 50% deductible for tax. LIFO inventory can shift taxable income up or down relative to accounting profit depending on price trends. Your tax return starts from accounting profit and gets adjusted from there.