Most companies that deduct the interest they pay on their income taxes, reduce the actual cost of the debt because the interest paid lowers their income taxes. Sometimes, companies present the after-tax cost of debt without acknowledging the before-tax cost. Although that may be effective for the current year, if the tax code changes, the company could lose the tax benefits and have to pay full cost without receiving the tax benefits. To calculate the before-tax cost of debt, you need to know the after-tax cost of debt and the income tax rate for the company.
To get started, you'll need information on the specific debt and the company's current tax rate. Often this information is well documented in a company's financial statements. You can sometimes pull the information you need directly from these statements, since they'll sometimes reflect the exact interest the company paid on their debts in a given timeframe. You may also be able to pull the information from a business's cash flow statements, since they'll often detail pretax money movements there. The after-tax metrics may be saved for their income statements.
Calculate Before-Tax Debt
Divide the company's effective tax rate by 100 to convert to a decimal. For example, if the company pays 29 percent in taxes, divide 29 by 100 to get 0.29. Subtract the company's tax rate expressed as a decimal from 1. In this example, subtract 0.29 from 1 to get 0.71.
Divide the company's after-tax cost of debt by the result to calculate the company's before-tax cost of debt. In this example, if the company's after-tax cost of debt equals $830,000. You'll then divide $830,000 by 0.71 to find a before-tax cost of debt of $1,169,014.08. If you need the after-tax cost, you can then backtrack to show the difference side by side. You can also express this number as a percentage by dividing the pretax cost of debt by total debt outstanding. This percentage can come in handy when presenting your findings to a team.
If you're pulling this information, chances are there's a reason. The data can be essential to moving a business forward, since it shows just how much interest they're paying on the debts they owe. If you can go through the balance sheets and calculate the pretax cost of debt for various items, you may be able to show businesses where they can cut back and save significant money.