Profit Before TaxProfit earned before accounting for income tax

The primary purpose of starting and running a business is to earn profits.

A business will usually achieve this by earning revenue first and then accounting for all expenses (including taxes).

Deducting all expenses from the total revenue will result in the business’s net profit.

The net profit is an important figure for any business as it can tell a few things: how much did the business truly earn for the period?

How much net income is available for dividend distribution? How well did the business do in controlling its costs?

The thing with net income though is that it includes income tax in its computation.

Income tax is an expense that a business does not have much control over.

It’s like, it’s a given that if a business makes a profit, it will so be incurring income taxes.

Don’t get me wrong though. Income taxes are a necessary expense. It’s important to properly account for them.

However, if you want to look at a business’s profits before applying the effect of income tax, you may want to take a look at its profit before tax (a.k.a. pre-tax income, EBT) instead.

The profit before tax figure includes all expenses the business incurred in its calculation except for one – income tax.

Since it doesn’t include income tax, one could say that the profit before tax figure only includes expenses that the business can control.

It’s also more convenient to compare profit before tax between businesses that operate in countries that have different income tax rates.

In this article, we will be talking about profit before tax.

What information can it tell us?

How does it compare to other measures of profit?

Is it important for a business?

Let’s find out as we go along with the article.

What is Profit Before Tax (PBT)?

Profit before tax is a measure of a business’s profitability that looks at its profit before accounting for income tax.

Essentially, it’s the profit that a business earns after deducting all expenses except for income tax.

This means that other than income tax, the profit before tax figure includes all operating and non-operating expenses in its calculation.

The profit before tax figure is also helpful in determining how much income tax the business has to pay.

Just apply the income tax rate to a business’s profit before tax and you’ll arrive at the amount of income tax that it has to pay.

We can also refer to profit before tax (PBT) as the pre-tax income or earnings before tax (EBT).

While profit before tax isn’t a usual key performance indicator in the income statement, it can still be found it.

A typical income will usually emphasize a business’s gross profit, operating profit, and finally, net profit or net income.

However, profit before tax is still useful in determining how well the business is doing in handling costs that it has more control over.

Unlike other expenses, income tax isn’t something that a business can control.

It is calculated based on how much the business earns.

So long as the business makes a profit, it will have to pay income taxes.

Profit before tax can also provide something that the net income cannot.

Since it doesn’t consider the impact of income taxes, it makes it much easier to compare two businesses that are subject to different income tax rates.

For example, businesses within certain industries may receive tax breaks while others don’t.

Removing the impact of income taxes will then make it easier to compare the profits of these businesses with each other.

Calculating Profit Before Tax

There are several approaches in which we can calculate profit before tax.

Let’s start first with the assumption that the calculation of net income or any other measures of profitability hasn’t been done yet.

To calculate the profit before tax, all we need to do is deduct all expenses from all revenues.

Since income tax isn’t calculated by this point, we won’t have to worry about that for now.

Put into formula form, the calculation should look like this:

Profit Before Tax = Revenue – Cost of Sales – Operating Expenses – Non-Operating Expenses + Non-Operating Income

It’s similar to the computation of net income with only the difference being that we stop before the calculation of income tax.

The next approach assumes that the EBIT (earnings before interest and tax) has already been calculated.

In this approach, we will only have to deduct the interest expense from the EBIT.

It should look like this in formula form:

Profit Before Tax = EBIT – Interest Expense

The last approach assumes that net income has already been calculated.

There are two ways to calculate profit before tax with this approach.

One is to divide the net income by 1 minus the tax rate.

The other is to simply add back the income tax.

Here’s they should look in formula form:

Profit Before Tax = Net Income ÷ (1 – Income Tax Rate)

-or-

Profit Before Tax = Net Income + Income Tax

Profit Before Tax vs Other Measures of Profitability

Unlike other measures of profitability in the income statement, the profit before tax isn’t emphasized that much.

However, it still provides a utility that the other measures do not.

The gross profit measures how much is left of revenue after deducting the cost of sales.

It focuses on the sales function of the business.

It does not consider all of the operations of the business.

For that, we have the operating income.

To arrive at the net income, we have to deduct the operating expenses from the gross margin.

The operating income provides us with information about the business’s core operations.

After the operating income is the EBIT or earnings before interest and tax.

It includes all non-operating income and expenses except interest in its calculation.

If the business only has operating income and expenses, then its EBIT and operating income will be equal.

It tells us how much the business has earned from its core operations and other non-operating activities.

The last measure of profitability that we’ll see in a typical income statement is the net income.

We calculate by deducting all expenses from all revenue.

It tells us how much the business earns after considering interest and income tax.

It also tells us how much of the revenue is available for dividend distribution.

The utility that the profit before tax provides is that it shows how well the company is handling costs that it can control.

It is also a better comparison tool than the net income when it comes to comparing businesses that are subject to different income tax rates.