Certified Financial Management Specialist Practice Exam

Which term refers to the profitability of a business while considering the opportunity costs?

1. Net Profit

2. Gross Profit

3. Economic Profitability

4. Accounting Profit

The correct answer is: Economic Profitability

The term that refers to the profitability of a business while considering the opportunity costs is economic profitability. Economic profitability takes into account not only the explicit costs (monetary expenses) of running a business but also the implicit costs, which include the opportunity costs associated with the owner's resources, such as time and capital. This concept allows for a comprehensive understanding of profitability, moving beyond simple revenue and expenses to include the value of alternatives that are foregone by choosing one business operation over another. In contrast, net profit simply accounts for the difference between total revenue and explicit costs, not considering what the business owner may have earned had they pursued alternative ventures. Gross profit focuses on the revenue from sales minus the cost of goods sold, leaving out operating expenses and other pertinent costs. Accounting profit is similar to net profit in that it considers only explicit costs and does not factor in the potential gains from alternative choices. Thus, economic profitability gives a fuller picture of a business's financial health by incorporating these vital considerations.