Paper profit definition
/What is a Paper Profit?
A paper profit is an unrealized capital gain on an asset. The amount of this profit is the difference between the asset's cost and the current market price. An actual profit is only realized after the asset has been sold to an unrelated third party. Thus, you cannot
Reasons for a Paper Profit
There are several reasons why someone might hold onto a paper profit, rather than selling the investment to generate a cash profit. These reasons are as follows:
Expectation of future value increases. The most common reason is that the investor believes that an investment will continue to increase in value, which may or may not be a valid belief.
Avoidance of tax payments. Another reason is that the investor wants to wait until the next tax year, in order to avoid paying taxes on the gain until then.
Waiting for tax reclassification. A third reason is that the investor wants to wait long enough for the gain to be classified as a capital gain and then sell it, which will reduce the resulting income tax rate.
Restrictions on sale. Fourth, an investor may be restricted from selling the asset, as is the case with restricted stock; in these situations, it can be quite difficult to sell the asset at all.
Retaining a majority interest. Finally, the ownership of an equity interest might give an investor a majority interest in a business, so that any sale of the equity might result in a loss of control. All of these are valid reasons for maintaining a paper profit.
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When is a Paper Profit Calculated?
A paper profit is calculated when a business uses mark-to-market accounting. This is required under the rules of the applicable accounting framework (such as generally accepted accounting principles), usually for short-term investments. Under mark-to-market accounting, the reporting entity is required to update its recorded investment in an asset to its market value as of the financial statement reporting date. This means that paper profits may be recorded on certain assets as of the end of a month, quarter, or year. These paper profits may be transitory, since a subsequent drop in market value would later result in a drop in a recorded investment.
The Difference Between a Paper Profit and an Actual Profit
The key difference between a paper profit and an actual profit is that an investor experiences a cash gain when there is an actual profit. This is not the case for a paper profit, since the underlying investment has not yet been liquidated. This means that there is no cash gain associated with a paper profit.
Terms Similar to Paper Profit
A paper profit is also known as an unrealized profit.