A company’s pre-tax profit is the profit it generates after paying all of its business expenses, except for the amount of money it pays in taxes. Net income is the company’s profit after paying all of its expenses, including income taxes. You can quickly and easily calculate the pre-tax profit of a company using its net income and current tax rate as key data points.
Why Exclude the Tax Rate?
If you know a company’s net income and tax rate, you can calculate its pre-tax profit. You can use the pre-tax profit to measure a company’s performance before the effect of taxes. If you own a company or work as an accountant for one, monitoring pre-tax profits can give you a great idea of how the company is performing over time.
Before you can get started, you'll need to know the tax rate that the business in question is paying. The Corporate Finance Institute states that the pre-tax rate of a company is also known as earnings before taxes (EBT). Often this metric includes profits before taxes, depreciation and amortization and is abbreviated as EBITDA. Expenses like taxes or depreciation are not included when calculating net profit. Net earnings are realized profits after all expenses including tax, depreciation and amortization.
EBITDA is a popular way to valuate a company based on overall performance even though it is not a GAAP principle. Many believe that EBITDA provides a more accurate illustration of a company’s day-to-day operating expenses and cash flow. This can make it easier to compare companies that might vary significantly across tax rates, debts and total expenses. Ultimately, the bottom-line is to accurately assess the profitability of a business.
According to the Corporate Finance Institute, there are two formulas for calculating EBITDA. In either case, you will exclude the cost of goods sold or COGS:
- Formula 1: EBITDA = Net Income + Tax Expense + Interest Expense + Depreciation & Amortization Expense
- Formula 2: EBITDA = Revenue – Cost of Goods Sold – Operating Expenses (Operating Costs) + Depreciation & Amortization Expense
How to Calculate With Net Income
If calculating for a publicly traded company, you should be able to find income statements in a company’s most recent 10-K annual report. You can find a public company’s 10-K annual report for free from the U.S. Securities and Exchange Commission’s online EDGAR database. You can also get this information from the investor relations page of a company’s website.
Imagine that you are calculating pre-tax profits for a hypothetical company called ACME. For this example, assume ACME’s tax rate is 35 percent. Find the income statement in the company’s annual report and identify the amount of its net income listed at the bottom of the statement. In this example, assume the company’s net income is $1 million.
Plug the company’s net income and tax rate into the following formula: net income = (1 - tax rate) x pre-tax profit. In this example, you would get $1 million = (1 - 0.35) x pre-tax profit.
Subtract the company’s tax rate from 1. In this example, subtract 35 percent, or 0.35, from 1 to get 0.65. This leaves $1 million = 0.65 x pre-tax profit.
Divide the net income by your result to calculate the company’s pre-tax profit. In this example, divide $1 million by 0.65 to get $1.5 million in pre-tax profit.
How to Use Pre-Tax Information
To truly get a feel for how profitable a company is, you'll need to compare that company's pre-tax data over time. This simply involves putting the current period's pre-tax profit up against that of previous given periods to determine any changes.
Using pre-tax data and EBITDA allows investors or lenders to apply principles of valuation regarding the financial health of a company by ignoring the tax rates, which can vary based on multiple factors, and by treating assets as continuously valuable. It enables and allows for a deeper examination beneath the topline of a balance sheet.
A company or small business growing and improving its operations should theoretically increase its pre-tax profit. Most importantly, you'll want to continue to compare these numbers moving forward to ensure the company continues to remain profitable.
Hashaw Elkins is a financial services and tax professional, as well as a project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw holds an MBA in Real Estate and an MSci in Project Management. She is further certified in organizational change management, diversity management, and cross-cultural mediation.