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What is a Normal Profit?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 13 November 2016
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Normal profit is the base profit which a business needs to earn in order for someone to keep the business going. It could be considered the profit which a business owner would reasonably expect to earn in order to break even. When businesses earn less than this, it is an indicator that they should switch industries or make other changes to their practices. Businesses which exceed this are doing well, and create an incentive for additional businesses to enter the market.

In an economy with perfect competition, businesses would theoretically all remain in a state of normal profit. If businesses started to earn more, other businesses would enter the market in the hopes of making profits as well, and this would drive the profit level back down to normal. However, perfect competition does not exist in any known markets, and thus true normal profit is very unusual.

Within the market, different sectors make differing degrees of profits. In some areas of the market, profit is actually relatively low. Other areas of the market demonstrate very large profits, although there may also be a corresponding high risk for people involved in those industries. It can also be challenging to break into industries where profits are high because companies may have refined their business practices and offerings in a way which makes it difficult for competitors to enter the market.

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A business making normal profit is making enough money to cover the expenses associated with running the business, including costs such as the time and energy invested in the business by the owner. Excess economic profits indicate that a business is pulling in more money than it needs to meet its expenses. These profits can be used to expand and grow the business, or to provide bigger payouts to key members of the business.

When people establish a new business, one of the things they do is make projections which will be used in the long term. The business may be expected to take a loss at first, gradually increasing profits to a point of normal profit, and then to eventually start earning more. Setting targets and goals can help people when the evaluate the efficiency and long term viability of a business. For example, if a restaurant owner believes that the business should break even in two years and it is still taking a loss at four years, it may be time to close the business and move on to something else.

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anon349918
Post 7

Normal profit is the minimum return required to satisfy shareholders. Managers view this return as an implicit cost that needs to be covered to keep shareholders from pulling their investment. A firm that earns zero economic profit, which includes the market value of all resources used in the production process (both explicit and implicit), just earns a normal profit.

Alternatively, a firm that earns an accounting profit equal to a normal profit earns a zero economic profit.

anon324710
Post 5

Normal profit, when calculated, includes cost, which is explicit plus implicit, thus including entrepreneurial opportunity cost. However, break even is often used in an accounting sense where the total cost is only explicit, but if an entrepreneur also includes implicit for a calculating break even, then normal profit can be the same as break even.

fify
Post 4

@burcinc-- Normal profit is also the minimum profit requirement for a company to keep shareholders. If the company falls below normal profit, it won't keep its shareholders for long, they will all rush to invest in a more profitable company.

It might not be a bad thing to be at normal profit, but as soon as a business falls below that margin, the fall could be inevitable. It's a thin line and it definitely keeps business owners on their toes.

burcinc
Post 3

@ddljohn-- That's right, normal profit equals cost for a business. If the business is making more money then it needs to cover costs, it is said that the business is making "economic profit" which is profit that is above normal profit.

Of course all businesses aim for economic profit, who wouldn't want to make more? But the issue with this is that the more businesses make, the more competitors will enter that market, just as the article mentioned. When there are more competitors, each business will lose some profit. So, in theory, no business should be able to have economic profit for very long.

Even though it might be more desirable to have economic profit, having normal profit is good too. Plus, it shows that the business has the potential to increase their profit in the future. At least we know that this business is in the market for the long term.

ddljohn
Post 2

A business would not ideally aim for normal profit right? If normal profit means that the business is making just enough to cover it's expenses, it also means that it is not profiting. Only if it makes above normal profit, it would actually have money left over to the business owner.

When I read the example in the article about businesses first incurring a loss and then later making normal profit, it made me realize how difficult it is to keep a business running.

If getting to normal profit is that hard, that means that the business that haven't gone bankrupt yet are actually extremely successful. Businesses must also start out with a lot of money to be able to get through months and years of losses until they can make normal profit, won't they?

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