Tax is a financial obligation that a taxpayer pays to a government. For companies, it represents an expense deducted from revenues to reach net earnings. However, stakeholders may consider pretax income to determine a company’s performance accurately. Before discussing how to calculate it, it is crucial to define this income.
What is Pretax Income?
Pretax income, also known as taxable income or earnings before taxes, refers to the income or profit generated by a company before accounting for tax expenses. It is the amount of income on which taxes get calculated. Pretax income is an essential financial metric to help determine a company’s tax liability. It helps calculate income taxes based on the applicable tax rates and regulations.
Pretax income is crucial for financial analysis, decision-making, and comparison between several companies. It provides insight into a company’s operational performance and profitability before the impact of taxes. By examining pretax income, investors, analysts, and stakeholders can assess a company’s ability to generate income from its core operations and evaluate its tax planning strategies and efficiency.
How does Pretax Income work?
Pretax income is a financial metric for a company’s profit or income before tax expenses get deducted. Companies can calculate it by subtracting deductible expenses, such as the cost of goods sold, operating expenses, interest expenses, and depreciation or amortization of assets, from the company’s total revenue. This calculation reflects the income generated by the company’s core operations before considering tax liabilities.
Once the pretax income is determined, applicable tax rates and regulations are applied to calculate the company’s tax liability. The tax liability is then subtracted from the pretax income to arrive at the net earnings or after-tax profit, which represents the actual income or profit that the company retains after accounting for all expenses, including taxes.
How to calculate Pretax Income?
The calculation of pretax income occurs through several stages. It starts with identifying a company’s total revenue for the given period. It includes all income generated from sales, services, or other sources. Next, it deducts expenses from the total revenue. These expenses typically include the cost of goods sold (COGS), operating expenses, interest expenses, and depreciation or amortization of assets.
Subtracting these expenses reflects the company’s operational costs and expenditures. Next, the calculation includes any non-operating income or expenses indirectly related to the core business operations. It consists of investment gains or losses, one-time extraordinary items, or any other non-recurring income or expenses.
Lastly, it subtracts the deductible expenses and non-operating income/expenses from the total revenue. The resulting figure represents the company’s pretax income. Based on the above explanation, companies can use the formula for pretax income below.
Pretax income = Total revenue – Deductible expenses – Non-operating income/expenses
Example
A company, Blue Co., had the following results for a financial year.
| Total revenue | $1,000,000 |
| Cost of goods sold | $400,000 |
| Operating expenses | $300,000 |
| Interest expenses | $50,000 |
| Depreciation | $30,000 |
| Non-operating income | $20,000 |
| Non-operating expenses | $10,000 |
Based on the above, the pretax income for Blue Co. will be as below.
Pretax income = Total revenue – Deductible expenses – Non-operating income/expenses
Pretax income = $1,000,000 – ($400,000 + $300,000 + $50,000 + $30,000) – ($20,000 – $10,000)
Pretax Income = $1,000,000 – $780,000 – $10,000
Pretax Income = $210,000
Conclusion
A company’s net income represents its earnings after tax. However, it may not accurately indicate its financial performance for a specific period. Therefore, stakeholders may compare its pretax income with others to get a better idea of how the company performed. This income represents profits or earnings before deducting tax expenses.
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