Depending on the context and subject, the words “interest and profit” can have a variety of meanings. In light of this article, we will examine the words from an economic standpoint.
Famous economists such as Adam Smith, Carl Menger, Fredrick Bastiat, Anne-Robert-Jacques Turgot, Baron de Laune, Knut Wicksell, Bertil Ohlin, Dennis Robertson, and others have developed economic theories in support of the concept of interest and interest rates.
This demonstrates the importance of these concepts and how they have gained traction over time. We will look at these concepts, their meaning in economics, and their differences.
INTEREST: Interest is a sum paid by a borrower to a lender (individual, corporate, or financial institution) that is greater than the amount borrowed and is usually calculated at a fixed rate. Interest is more akin to a compensation paid by a borrower to a lender for the time he willingly dispossessed himself of his money, incurring the inconvenience of not being able to use it whenever he pleased.
The loan amount generates interest during the loan’s active period, and at maturity, the loan amount is paid in full, along with the interest.
It is also critical that money deposited in a commercial bank earns interest and thus qualifies as a loan. To put it another way, the depositor is the lender and the bank is the borrower. Interest and interest rates are affected and determined by the law of demand and supply in economics, but unlike the supply of goods and services, interest has to do with the demand for loans and the availability of lenders. In a nutshell, it is the supply and demand for money.
PROFIT: Profit is the difference between a business entity’s total income or revenue and its total expenditure. In a nutshell, it is the result of subtracting total cost from total revenue made. It is also an amount made or gained by the owner of an asset, enterprise, or investment as a result of a business sale. It is also the total amount earned from sales after deducting the cost price. Profit is influenced by the law of demand and supply of goods and services, which in turn influences sales and cost of sales.
Every business should be able to make a profit. This is because it sustains the business and ensures its survival. Profit cannot be realized unless a company’s total revenue exceeds its total expenditure within a given time frame. When a business owner makes a profit, he can choose to distribute it to the shareholders or reinvest a portion or all of it back into the business to improve output and, in turn, profit. Profit can be viewed through two lenses.
Gross Profit: Gross profit is the total revenue generated in a given time period before deducting costs.
Net Profit: The actual profit realized by the business after deducting the cost price and the cost of production. The net profit is also known as the business’s main profit.
In this context, revenue refers to the total amount of money earned by a company from sales and services rendered.
According to the above definition and conceptual analysis, interest and profit have a mutual economic umbrella, but they have different inclinations. According to the conceptual elucidation, the concepts of interest and profit are economically distinct.
1. Interest is a sum predetermined to be paid by a borrower above the actual amount borrowed. Profit, on the other hand, is a sum paid to or received by the owner of an asset, business, or investment after deducting the capital investment.
2. Interest is only paid to a lender by a borrower in exchange for an agreed-upon sum borrowed, whereas profit is paid to the owner of an asset in exchange for a sale of the asset or investment.
3. Interest is fixed and paid at regular intervals. In that case, it cannot be paid or received until the agreed-upon date has passed. In other words, interest is due when the loan matures. Profit, on the other hand, is payable and can be collected at any time. Profit is determined by sales, which are not always predetermined or fixed.
4. Profit is calculated after the cost of the asset or capital investment is deducted. Interest, on the other hand, is not subject to any deduction; rather, it is determined by the parties involved (the Lender and the Borrower) based on the actual amount borrowed as well as the fixed date for payment.
5. Interest is typically calculated on a daily, weekly, monthly, or annual basis. This means that once the lender and borrower agree on a payment date, it cannot be paid or received earlier or later than the agreed date, whereas profit is calculated based on the time or period of sales or investment maturity.
6. In a business economy, interest rates are determined or affected by the demand and supply of money supply, whereas profit is determined and greatly affected by the law of demand and supply of goods and services.