Profit before tax (PBT) is a measure of a company’s profitability that looks at the profits made before any tax is paid. It matches all the company’s expenses, which include operating and interest expenses, against its revenues but excludes the payment of income tax.
A majority of entrepreneurs start their companies at least in part because of the pride of owning a venture and the satisfaction that comes along with it. But other than that, they also start businesses in order to generate profits. There are several metrics that company owners can use to determine whether their companies are profitable. One such indicator is profit before tax.
Breaking Down Profit Before Tax
Profit before tax accounts for all the profits that a company generates, whether through continuing operations or non-operating activities. It’s also known as “earnings before tax (EBT)” or “pre-tax profit.” The PBT calculation was invented to deal with the constantly changing tax expense. It provides company owners and investors with a good idea of just how much profit a company is making.
PBT is listed on the income statement – a financial document that lists all the company’s expenses and revenues. It is usually the third-to-last item on the income statement.
How to Calculate Profit Before Tax
To calculate the PBT of a company, one must follow several steps. They are:
1. Collect all the financial data about the income earned by the company
The earnings can come from different sources such as rental income, discounts received, and total sales, among others. Other unique income sources include service income, interest earned on bank accounts, and bonuses.
2. Evaluate deductible expenses
If one is running a business, the most likely expenses they are going to incur are rent, debt, utilities, and the cost of goods sold. Other company owners also maintain records of health expenses, unpaid and accrued wages, as well as charitable contributions.
3. Subtract the deductible expenses from the earned income
The difference is what is referred to as the earnings/profit before tax.
Illustrating Profit Before Tax
The concept of profit before tax is demonstrated in the example below:
Profit Before Tax
Income Tax Expense
Profit Before Tax = Revenue – Expenses (Exclusive of the Tax Expense)
Profit Before Tax = $2,000,000 – $1,750,000 = $250,000
PBT vs. EBIT
Profit before taxes and earnings before interest and tax (EBIT), are both effective measures of a company’s profitability. However, they provide slightly different perspectives on financial results.
The main difference is that while PBT accounts for interest in its calculation, EBIT doesn’t. EBIT is the measure of a company’s profits before any interest or income tax is paid. It’s computed by finding the sum of the sales revenue less the cost of goods sold and operating expenses.
To illustrate the fact, assume Company XYZ reports sales revenue amounting to $2,500,000, $1,200,000 in cost of goods sold, and $300,000 in operating expenses. The earnings before interest and tax can be found as follows: $2,500,000 – ($1,200,000 + $400,000) = $1,000,000. It requires subtracting the cost of goods sold and operating expenses from the total revenue.
In an income statement, EBIT is the operating income, and it determines a company’s operating performance. It does not incorporate the impact of tax regulations and debt, which can vary significantly in every period. With the exclusions, EBIT provides a good estimate of the performance over a given period.
Contrary to EBIT, the PBT method accounts for the interest expense. It’s computed by getting the total sales revenue and then subtracting the cost of goods sold, operating expenses, and interest expense.
If Company XYZ reported an interest expense of $30,000, the final profit before tax would be: $1,000,000 – $30,000 = $70,000. It means that the business generated $70,000 in profits after paying operating expenses and interest but before paying the income tax.
Significance of Profit Before Tax
Profit before tax is one of the most important metrics of a company’s performance. For one, it provides internal and external management with financial data on how the company is performing. Since it does not include tax, PBT reduces one variable, which could come with different indicators that influence the final financial data results.
For example, if a particular company is in an industry that experiences considerable tax benefits, then it will help to increase its net income. However, if the industry is subjected to unfavorable tax policies, then the company’s net income would decrease. By doing away with the income tax expense, company owners are able to compare the operations of different companies regardless of the existing tax laws.
Profit before tax is also known as earnings before tax. It is a measure of a company’s profitability before it pays its income tax. It provides investors and company owners with useful financial data regarding the business’ operating performance.
By excluding the tax factor, PBT minimizes the potential impact of taxes on the company’s profits. In such a way, profit before tax helps individuals to focus on operating profitability as a singular indicator of performance.
Thank you for reading CFI’s guide to Profit Before Tax (PBT). To keep advancing your career, the additional CFI resources below will be useful: