The object of starting any business enterprise is to make some profit. Profit from such an endeavor can best be defined as that surplus which remains in the hands of the business owner after setting off all the expenses incurred in normal course of business for obtaining that surplus. Accounting profit is, however, not as simple as this definition. For example, a person runs a retail business, and the supplier provides goods worth $200 to the retail businessman. This businessman is able to sell it at $210. This means, he is left with a surplus of $10. On the face of it, the businessman has indeed made some profits. But in fact, he has not set off proportionate establishment and administration costs. Such costs when added to the cost of the good proportionately might bring up the cost of the good to $220. Effectively, the sale price of $210 is not good enough! This addition of costs to the goods is done through cost accounting methods.

Manufacturing units incurs both direct costs, and indirect costs. Direct costs/ expenses include raw material costs, consumable costs, factory labor costs, power for manufacturing, factory maintenance costs etc. Gross profit for any period is arrived at after setting off these production expenses against the sales for the relevant period. Generally, business enterprises have a policy of predefining the profit margins. They do this by adding a percentage of cost price of the good to the sale price. Net profit is arrived at after deducting establishment expenses, salaries, administration expenses, finance expenses, etc., from the gross profit. The accounting statement that lists various expenses that are set off against the gross profit to arrive at the net profit is commonly referred to as the Profit and Loss Account, or the Statement of Profit and Loss. Tax is payable as a ratio of this Net Profit, and accordingly the surplus left eventually in the hands of the proprietor or owners of the business is equal to net profit less the tax.

Accounting profit is not to be confused with cash flows of the business. Even though the books show substantial accounting profits, the business may actually be facing cash crunch. This is because part of the profits may actually be locked in non-liquid assets such as debtors, and raw material stocks. This may force the business enterprise to approach banks for funds. Another common problem in accounting profit is the differentiation between capital expenditures and revenue expenditures. Capital expenditures are those expenditures that are set off or amortized over a long period, while revenue expenses are those that are specifically incurred during the year and completely consumed during the year. Unlike revenue expenditures, capital expenditures are not completely consumed in a single year. There are accounting standards, principles and policies for accounting profit earned or loss incurred in any year. The most commonly followed accounting standard is called GAAP or the Generally Accepted Accounting Principles.

Economic accounting profit differs from normal accounting profit by a margin that could have been the business enterprise`s profit, had some other alternative been taken. Effectively, this type of accounting indicates whether the decision taken was right or wrong. Such cost of the option/alternative is called opportunity cost. Obviously the business enterprise has incurred a loss, if the profit made with that alternative proposal would have been higher.