What it means
Pretax earnings are sometimes called earnings before tax or profit before tax, and all three phrases mean the same line. It is the point at which every commercial cost, including the cost of borrowing, has been taken into account but the tax authority has not yet had its share.
The figure is popular with analysts for comparison purposes. Two similar companies in different countries or with different loss histories can report very different net income while their pretax earnings tell a much cleaner story about trading performance.
It also sits at the boundary between operating and financing decisions. Operating profit ignores interest, so the step down to pretax earnings is where the cost of the company's debt shows up, which is why heavily borrowed businesses often show a wide gap between the two.
Pretax margin is the usual way to make it comparable across sizes. Dividing pretax earnings by revenue gives a percentage that can be tracked over time or compared with peers without the distortion of different tax positions.
One nuance is that pretax earnings still include one-off items. A large disposal gain or restructuring cost can flatter or depress the figure, so analysts often look at it alongside an adjusted measure that strips out items management does not expect to repeat.
It is also not the number the tax authority works from. Taxable profit starts with pretax earnings and then adjusts for items such as disallowed entertaining, capital allowances and timing differences, which is why the tax charge in the accounts rarely equals the headline rate multiplied by the pretax figure.
In practice
Real-world examples.
Example
A manufacturer reports operating profit of $3,000,000 and interest costs of $900,000, giving pretax earnings of $2,100,000. The investor reading it immediately sees that debt is absorbing $900,000, or 30% of operating profit, before the tax authority takes anything at all.
Example
Two retail chains of similar size both post pretax earnings of about $5,000,000, but one reports far higher net income because it is using brought-forward tax losses from earlier years. The pretax line is the fairer basis for comparing how the shops actually traded during the period.
Example
A bank reviewing a loan application uses pretax earnings rather than net income when assessing whether the borrower can service more debt. It wants to see trading performance before tax planning choices, and it will add back interest separately to test the cushion available for repayments.
Formula
Calculation
Pretax earnings = Revenue - Cost of goods sold - Operating expenses - Interest expense
Pretax margin = Pretax earnings / Revenue
Net income = Pretax earnings - Income tax expense
A specialist equipment distributor reports revenue of $8,400,000 and cost of goods sold of $4,200,000, giving gross profit of $8,400,000 - $4,200,000 = $4,200,000. Operating expenses of $2,600,000 bring operating profit to $4,200,000 - $2,600,000 = $1,600,000.
Interest on the company's bank debt is $200,000, so pretax earnings are $1,600,000 - $200,000 = $1,400,000. The pretax margin is $1,400,000 / $8,400,000 = 16.7%. At an effective tax rate of 25%, the tax charge is $1,400,000 x 25% = $350,000, leaving net income of $1,400,000 - $350,000 = $1,050,000.Case study
Seen in the real world.
This is an illustrative, fictional case. Halbrook Components, a mid-sized parts supplier, celebrated a year in which net income jumped from $700,000 to $1,250,000 and management proposed larger bonuses on the strength of it.
The finance director looked one line higher. Pretax earnings had risen only modestly, from $1,000,000 to $1,100,000, and most of the improvement in net income came from a one-off tax credit relating to research spending in earlier years.
In the illustrative outcome, the bonus scheme was rebased on pretax earnings so that it rewarded trading performance rather than tax timing. The fictional board also asked for the pretax margin to be shown on every monthly report, which quickly revealed that rising interest costs, not weak sales, were the real pressure on profitability.
Watch out
Common mistakes.
- Treating pretax earnings and operating profit as the same figure. Operating profit is calculated before interest, so the two differ whenever a company has debt.
- Comparing net income across countries without checking the pretax line. Different tax rates and credits can make identical trading performance look very different.
- Assuming pretax earnings equal the amount actually taxed. Taxable profit is calculated under tax rules and usually differs from the accounting figure.
Questions
People also ask.
Is pretax earnings the same as EBIT?
Not quite; EBIT excludes interest, while pretax earnings are after interest but before tax.
Why do analysts like this measure?
It removes the distortion of tax rates, credits and past losses, making trading performance easier to compare.
Where do I find it?
On the income statement, immediately above the income tax expense line, often labelled profit before tax.
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