Pretax Earnings Definition

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Pretax Earnings Definition

What Are Pretax Earnings?

Pretax earnings are a company’s profits after deducting all operational expenditures, including interest and depreciation, from total sales or revenues, but before deducting income taxes. Because pretax profits do not include taxes, this metric allows firms’ inherent profitability to be compared across sectors or geographic locations where corporate taxes vary. For example, whereas firms located in the United States have the same federal tax rates, they face separate state tax rates.

Also known as pretax income or earnings before tax (EBT).

Key Takeaways

  • Pretax earnings are the profits left over after deducting all operational expenditures, including interest and depreciation, from total sales or revenues, but before deducting income taxes.
  • Pretax earnings give information about a company’s financial performance before taxes are applied.
  • Many people believe that pre-tax profits are a more accurate indication of a company’s profitability and health over time.

How Pretax Earnings Work

The pretax profits of a corporation give information about its financial performance before the effect of taxes is applied. Some believe this statistic to be a more accurate indicator of success than net income since tax credits, carry forwards, and carry backs may all have an impact on a company’s tax costs in a given year. Pretax earnings are determined by deducting a company’s operational expenditures from its gross margin or revenue. Depreciation, insurance, interest, and regulatory penalties are examples of operating expenditures. For example, a factory with $100 million in sales in a fiscal year may have total operating expenditures (including depreciation and interest payments) of $90 million, minus taxes. Pretax profits in this scenario total $10 million. After-tax profits, or net income, are calculated by subtracting corporate income taxes from $10 million in pretax earnings.

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Businesses may want to measure pre-tax profits rather than net income since tax deductions and employee perks paid in one quarter may vary from another. Because it eliminates the variable variances caused by tax concerns, pre-tax profits are considered as a more consistent indicator of corporate success and fiscal health over time.

Pretax Earnings Margin

Analysts and investors use pretax profits to compute the pretax earnings margin, which indicates a company’s profitability. The pretax earnings margin is the pretax earnings to total sales ratio of a corporation. The bigger the company’s pretax profit margin, the more lucrative it is.

Assume Company ABC makes a yearly gross profit of $100,000. It has $50,000 in operational expenditures, $10,000 in interest expenses, and $500,000 in revenues. Pretax earnings are computed by deducting operational and interest expenses from gross profit, i.e. $100,000 – $60,000 = $40,000. The pretax profits margin for the current fiscal year (FY) is $40,000 / $500,000 = 8%.

However, Company XYZ, with $750,000 in sales and $50,000 in pretax profits, has a greater profitability in dollars than Company ABC. XYZ, on the other hand, has a smaller pretax profits margin of $50,000 / $750,000 = 6.7%.

Pretax Earnings Vs. Taxable Income

Profits Before Taxes (EBT) are the earnings before taxes reflected on a company’s income statements. It is the amount to which the corporation tax rate is applied in order to compute tax for financial reporting purposes. Pretax earnings are calculated using Generally Accepted Accounting Principles criteria (GAAP).Taxable income, on the other hand, is computed using Internal Revenue Service-mandated tax codes (IRS).It is the amount of revenue on which the company will pay income tax throughout the fiscal term.

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