Pre-tax income, also known as pre-tax earnings, represents a company’s or individual’s net income before subtracting any income taxes. Pre-tax income still includes deductions related to operating expenses and interest.
For companies, pre-tax income provides insight into their profitability and cash flow before the impact of taxes and can be a benchmark metric investors use to compare against the market.
Pre-tax earnings are often considered a more accurate representation of the company’s overall business performance and health over time.
Pre-tax income vs. taxable income
While pre-tax income is the company’s net income before taxes, taxable income is the company’s earnings after taxes.
Taxable income is the company’s income subject to income tax. Businesses can calculate taxable income by subtracting any tax deductions and credits from their pre-tax income using the tax codes relevant to their operating jurisdiction.
How to calculate pre-tax income
The formula for calculating pre-tax income is to subtract the company's total operating expenses from its total gross revenues:
Total gross revenue − operating expenses = pre-tax income
Gross revenue includes all revenue the business generates. Operating expenses include but aren’t limited to employee salaries, sales and marketing fees, accounting and legal fees, depreciation, interest income, and regulatory fines.
Pre-tax income example
For example, say a company’s revenue in a fiscal year totals $12 million. The company’s total operating expenses are $8 million, which include employee salaries and benefits, cost of goods sold, maintenance costs, administrative expenses, interest, depreciation, and amortization.
According to the formula, the company’s pre-tax income is $4 million:
$12 million in total revenue − $8 million in operating expenses = $4 million pre-tax income
What is a pre-tax earnings margin?
The pre-tax earnings margin is a metric that measures a company’s profitability before accounting for taxes and is used to evaluate the company’s efficiency in generating profits before paying any taxes.
Pre-tax income helps calculate the pre-tax earnings margin. To calculate the pre-tax earning margin, divide the company’s pre-tax income by its total revenue. This number shows the percentage of revenue the company can retain as profit before paying taxes. So, a higher pre-tax earnings margin reflects a more profitable business.
Why is pre-tax income important?
Pre-tax income is a critical metric that provides ample financial insight for businesses. Reasons why pre-tax income is essential for any business include the following:
- Tax calculation. Understanding pre-tax income is necessary for effective tax planning. Businesses calculate the amount of taxable income or the taxed amount by applying applicable tax rates using pre-tax income.
- Business performance. Pre-tax income is a significant indicator of financial performance and helps companies accurately assess their profitability and cash flow. It provides insights into operational efficiency and the ability to cover expenses and can help to compare against others in the same industry or market.
- Cash flow. Pre-tax income is closely tied to cash flow and helps businesses assess their capacity and ability to cover operating expenses, debts, and other financial obligations.
- Investor assessment. Pre-tax income represents a company's ability to generate profits from investments. Investors may use pre-tax income to evaluate a company's financial health and operational performance as part of their assessment of a company’s success.
- Budgeting. Pre-tax income helps businesses set budgets and determine financial feasibility for various projects or initiatives. Pre-tax income serves as a basis for deciding how much to allocate toward various expenses, initiatives, investments, and savings.
- Creditworthiness. Lenders and creditors may also use pre-tax income to assess a company's creditworthiness. Pre-tax income helps lenders evaluate a company’s capacity for loan repayments based on their overall financial performance.
- Strategic planning. Pre-tax income helps businesses strategically plan for the future. Understanding pre-tax income helps in pricing strategies, investment decisions, strategic workforce planning, and evaluating the financial feasibility of expansion and growth.
- Legal compliance. Pre-tax income is a critical factor in accurate legal and regulatory compliance reporting. Businesses use pre-tax income for preparing financial statements, complying with financial reporting and employment regulations, and global payroll compliance.
Disclaimer: The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. © 2024 Velocity Global, LLC. All rights reserved.
