The following points highlight the five main constituents of gross profit.
The constituents are: 1. Imputed Costs 2. Implicit Returns 3. Normal Profit 4. Non-entrepreneurial Profit 5. Net Profit.
Gross Profit Constituent # 1. Imputed Costs:
This includes costs like maintenance and depreciation charges. To arrive at Net Profits, these are to be deducted from the Gross Profit.
Gross Profit Constituent # 2. Implicit Returns:
This includes expenses like implicit rent, implicit wages and implicit interest for the factors—land, labour and capital owned and supplied by the entrepreneur himself. In many business firms the entrepreneur uses his own land, invests his own capital and also he himself works as manager.
Gross Profit Constituent # 3. Normal Profit:
This Profit is also called the implicit costs of the entrepreneurial input. It is the imputed minimum return for the entrepreneur’s organisational functions.
The businessman may have been busy in organising, coordinating and managing the entire business himself. But he may have been contended with income received after meeting all expenses of production. If he had not performed the work of management himself he might have employed a manager to whom he would have paid wages. Thus his gross profit included implicit wages which are required to be deducted for calculating net profit.
Gross Profit Constituent # 4. Non-Entrepreneurial Profit:
‘This includes windfall gains, monopoly gains etc., which accrue to the entrepreneur as a result of chance events and market imperfections. This Profit is not related to entrepreneurial ability in the strict sense.
Gross Profit Constituent # 5. Net Profit:
It is the pure economic profit earned by the entrepreneur for his services and efficiency.
In short we can say:
Gross Profit = Net profit + implicit rent + implicit wages + implicit interest + normal profit + depreciation and maintenance charges + non-entrepreneurial profit.
Net Profit is the reward earned exclusively by the entrepreneur for the entrepreneurial functions.
In Net Profit the reward includes for:
(i) Uncertainty bearing,
(ii) Reward for co-ordination,
(iii) Reward of his ability,
(iv) Reward of innovation,
(v) Monopoly gains, and
(i) Reward for Uncertainty Bearing:
This reward is one of the main functions of an entrepreneur in the present capitalist system which leads to Profit.
(ii) Reward for Co-ordination:
The present system of production is one of the coordinating the right quantity of factors in right proportion Entrepreneur Co-ordinates the different factors of production, such as land, labour and capital in the productive process. By efficient organisation, he minimizes the costs of production and is therefore entitled to super-normal profit.
(iii) Reward for his Ability:
Business profit is the reward for risk borne by the entrepreneur. The entrepreneur alone bears the risks involved in the business, so he is entitled to Profit.
(iv) Reward for Innovation:
Profit is also the reward earned by the entrepreneur for innovations. He may adopt new techniques, new products, new markets in order to earn more profit.
(v) Monopoly Gains:
At present it has been seen that some shrewd entrepreneurs are able to push up their sales by making their products distinct and superior to others. In this process, they also succeed in raising the prices of their products. Thus, their profits goes high when they create semi-monopolistic conditions for themselves.
Sometimes, entrepreneurs earn higher profits which are like a windfall either by the outbreak of war or as a result of the closing down of some of the other firms for some time on account of labour problems. It is the Net Profit which may be positive or negative. A negative net profit means a loss.
Net Profit = Gross Profit – (implicit rent + implicit wages + implicit interest + normal profits + depreciation and maintenance charges + non-entrepreneurial profit)