Why economic profit is important
The best companies calculate economic profit to make informed business decisions and profitably allocate their resources. But because economic profit or loss is generally not disclosed, the metric isn't too helpful for deciding whether to buy a stock. Instead, investors should evaluate a company's management team and its track record of entering new markets to drive overall growth.
The same concept of economic profit management teams utilize can be useful on a personal level. For instance, you might use the economic profit concept to determine whether to start a business.
Let's say you expect a new business endeavor to generate $100,000 in year one, while it will only cost $80,000 to get started. Your accounting profit would be $20,000. However, in order to start the business, you would need to quit your full-time job and reduce to part-time hours, forgoing $50,000 in income in year one.
The economic loss to you would be negative $30,000 for the first year ($100,000 of revenue minus $80,000 of start-up costs minus $50,000 of lost income). You might decide to go ahead with this plan, though, if there are no other start-up costs after year one, your ongoing expenses significantly drop, and your revenue increases. The initial economic loss could become a long-term economic profit.
The same principle can be used in other ways when deciding how to spend or invest your money. Perhaps you have a choice between buying a new car with a warranty or a used car with no warranty. The new car has a higher up-front expense but lower maintenance expenses for a time, while the used car has a lower up-front purchase price but higher maintenance expenses. The same concept applies to buying or renting a home and investing money. Considering economic profit or loss can help you make better long-term financial decisions.