The term profit has distinct meanings for different people, such as businessmen, accountants, policymakers, workers, and economists. Profit simply means a positive gain generated from business operations or investment after subtracting all expenses or costs. The concept of profit entails several different meanings. Profit may mean the compensation received by a firm for its managerial function. It is called normal profit which is a minimum sum essential to induce the firm to remain in business. Profit may be looked upon as a reward for true entrepreneurial function. It is the reward earned by the entrepreneur for bearing the risk. It is termed a supernormal profit analysis.

In economic terms, profit is defined as a reward received by an entrepreneur by combining all the factors of production to serve the needs of individuals in the economy faced with uncertainties. In accountancy, profit implies an excess of revenue overall paid-out costs. Profit in economics is termed as a pure profit economic profit or just profit. Important definitions of profit as given by different authors are as follows:

Prof. Marshall: Profit is the earning of management.

Walker: Profit is the rent of ability.

Croome: Profit is the reward for uninsured risks.

Ely: Profit is a surplus over and above the expenses of production.

Taussig: Profit is a mixed and vexed income.

Thomas S.E.: Pure profit is a payment made exclusively for bearing risk. The essential function of the entrepreneur is considered to be something that only he can perform. This something cannot be the task of management, for managers can be hired, nor can it be any other function which the entrepreneur can delegate. Hence, it is contended that the entrepreneur receives a profit as a reward for assuming final responsibility, a responsibility that cannot be shifted on the shoulders of anyone else.

Keynes: Profit is the engine that drives the business enterprise.

Thus, profit is the surplus that remains in the hands of the entrepreneur after paying rent, wages, and interest on borrowed capital. It is the reward for taking risks and uncertainties. It results from the continuous innovation and dynamism of the economic activities.

Gross Profit

Gross profit is the surplus that accrues to a firm when it deducts its total costs in producing products from its total income received from the sale of goods. In producing goods, a firm incurs explicit costs and implicit costs, In ordinary language, the term profit is used in the sense of gross profit. The gross profit is the difference between the total revenue and total book of account cost-explicit cost.

Gross profit = Total Revenue – Total Explicit Costs

Gross Profit = Net profit + Implicit Rent + Implicit Wages + Implicit Interest + Normal Profit + Depreciation and maintenance charges + Non-entrepreneurial profit + Insurance charged

Therefore, economists regard a businessman’s profit as gross profit as distinct from pure or net profit because it includes the following constituents.

  1. Rent on land: The businessman may have used his land to erect the factory so that he may be saved from the bother of paying rent to some other landlord. This rent is included in his profit. This is implicit or imputed rent which is not a part of his profit. Had he hired land from some other person, he would have paid its rent.
  2. Interest on capital: Similarly, entrepreneurs may have used their capital in their business to avoid the inconvenience of borrowing from some other person. This implicit interest is again included in his gross profit. If he had borrowed the same amount of capital for investment in his business, he would have paid interest on it.
  3. Wages of management: The businessman may have been busy organizing, coordinating, and managing the entire business. But he may have been contented with the income received after meeting all production expenses. If he had not performed the work of management himself, he would have employed a manager to whom he would have paid wages. Thus his gross profit included implicit wages that must be deducted for calculating net profit.
  4. Depreciation charges: During production, machinery and plants depreciate and become obsolete. Expenses incurred on their repairs and replacements are a part of the cost of production. Hence they should be excluded from gross profit to calculate net profit.
  5. Insurance charges: Every firm gets itself insured against fire, accidents, and losses of other kinds for which it pays large premiums annually to insurance companies. They are a charge on the revenue of the firm and therefore do not form part of gross profit.

Net Profit

Net profit is the profit that accrues to an entrepreneur for his functions as an entrepreneur. These functions include risk-bearing ability, innovating spirit, bargaining ability, etc. Net profit is the reward of an entrepreneur for (i) organizing a business and undertaking risk (ii) his bargaining ability with the customers (iii) adopting new techniques of production (iv) monopoly gains if any (v) windfall gains due to sudden rise in the prices of goods.

Net Profit = Total Revenue – ( Total Explicit Costs + Total Implicit Costs)

Net, true, economic, or pure profit is the residue left to the entrepreneur after deducting all the items enumerated above from gross profit. Net profit, however, includes the following elements.

  1. Reward for uncertainty bearing: Pure profit that an entrepreneur receives is the reward of bearing uninsurable risks and uncertainties. Uncertainty-bearing is one of the main functions of an entrepreneur in the present capitalist system which leads to profit.
  2. Reward for coordination: The present system of production is one of coordinating the right quantity of factors in the right proportions. An entrepreneur who combines them in the right way can produce larger quantities of the product with the minimum cost and thus earn the largest amount of profit.
  3. Rent of ability: Net profit accruing to the businessman also includes the rent of his ability. An entrepreneur with superior business acumen can earn a larger profit than the others.
  4. The reward of innovation: An entrepreneur who innovates by bringing out a new product or technique of production earns a higher profit than others.
  5. Monopoly gains: The modern market system is characterized by the existence of imperfect markets. Some shrewd entrepreneurs can push up their sales by making their products appear distinct and superior to others. In this process, they also succeed in raising the prices of their products. Thus their profits swell when they create semi-monopolistic conditions for themselves.
  6. Windfalls: Pure profit earned by an entrepreneur may also include fortuitous or chance gain. The demand for his product may suddenly rise either due to the outbreak of war or as a result of the closing down of some of the other firms for some time on account of labor trouble. Therefore, it earns higher profit which is like a windfall.

Risk Theory of Profit

Frederick Barnard Hawley in 1893 advocated the risk theory of profit. According to Hawley, risk in business may arise due to such reasons as product obsolescence, unexpected collapse in the market prices, non-availability of essential raw materials, introduction of improved substitutes by competitors, risk due to fire, war, and the like.

Risk-taking is considered an inevitable precondition of dynamic production, and those who take a risk have a sound claim of a separate reward, termed ‘profit’. Hawley refers to profit as the price or reward society pays for assuming business risk. Risk bearing is a function of an entrepreneur and profit is the reward for performing this function.

Hawley suggests that businessmen would not assume risk without expecting adequate compensation over actuarial value, that is premium on calculable risk. Hawley states that profit consists of two parts: The first part is the compensation for the average loss accompanying the various classes of risks necessarily assumed by the entrepreneur. The other part is the inducement to suffer the prospect of being exposed to risk.

Thus, according to the risk theory, profit is regarded as a reward for risk-taking or risk-bearing. According to Hawley, the profit of an undertaking, or residue of the product after the claims of the land, labor, and capital are satisfied, is not the reward of management or coordination but of the risk and responsibilities. Profit consists of two-part, which are as follows:

  • First, it represents compensation for actual or average loss supplementing the various classes of risk.
  • The other part represents a penalty to suffer the consequences of being exposed to risk in entrepreneurial activities.

According to Drucker, there are four kinds of risk. They are replacements, obsolescence, risk proper, and uncertainty. The first two are calculated and therefore they are insured. But the other two are unknown and unforeseen risks. It is for bearing such risk profit is paid to the entrepreneur. Therefore, entrepreneurs have to undertake these risks and claim profit as a reward for bearing these risks.


The risk theory of profit has been criticized on the following grounds:

  1. No functional relationship between risk and profit: Those persons who dare to take high risks in certain businesses may not necessarily earn high profits.
  2. Entrepreneur’s ability results in profit: In this connection, Prof. Carve has said that “Profit is not based on entrepreneur’s ability to undertake the risks of the business, but rather as his capability of risk avoidance.”
  3. Incomplete theory: From the business point of view, all enterprises are risky and an element of uncertainty is present there. But every entrepreneur aims at making large profits which is also uncertain. Therefore, Hawley’s Risk Theory can also be called as an incomplete theory of profit.
  4. Impractical analysis of profit and size of risk: The amount of profit is not related to the size of the risk undertaken. If it were so related, every entrepreneur would involve himself in huge risks to earn large profits.
  5. Only risk matters: This theory mostly disregards many other factors attributable to profit and concentrates on risks and risks alone.

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