Profit Before Tax (PBT): Definition, Calculation & Importance

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 expensesInterest ExpenseInterest expense arises out of a company that finances through debt or capital leases. Interest is found in the income statement, but can also, against its revenues but excludes the payment of income tax.

 

 

A majority of entrepreneursEntrepreneurAn entrepreneur is a person who starts, designs, launches, and runs a new business. Instead of being an employee and reporting to a supervisor 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 statementIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or – 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 soldCost of Goods Sold (COGS)Cost of Goods Sold (COGS) measures the “direct cost” incurred in the production of any goods or services. It includes material cost, direct. 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:

Sales Revenue$2,000,000Total Expenses($1,750,000)Profit Before Tax$250,000Income Tax Expense($50,000)Net Income$200,000

 

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)EBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income. EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue., 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 incomeOperating IncomeOperating income is the amount of revenue left after deducting the operational direct and indirect costs from sales revenue., 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.

 

Summary

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.

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• EBITDAEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability from core operations before the impact of capital structure. Formula, examples
• EBIT vs. EBITDAEBIT vs EBITDAEBIT vs EBITDA - two very common metrics used in finance and company valuation. There are important differences, pros/cons to understand.
• The Ultimate Cash Flow GuideThe Ultimate Cash Flow Guide (EBITDA, CF, FCF, FCFE, FCFF)This is the ultimate Cash Flow Guide to understand the differences between EBITDA, Cash Flow from Operations (CF), Free Cash Flow (FCF), Unlevered Free Cash Flow or Free Cash Flow to Firm (FCFF). Learn the formula to calculate each and derive them from an income statement, balance sheet or statement of cash flows
• Valuation MultiplesTypes of Valuation MultiplesThere are many types of valuation multiples used in financial analysis. They can be categorized as equity multiples and enterprise value multiples.