What it means
Pretax profit, also called profit before tax or earnings before tax, is what remains after all operating costs and interest charges but before corporation tax. Turning it into a margin, a percentage of revenue, makes the figure comparable across companies of very different sizes.
The measure sits between operating margin and net margin, and each of the three answers a different question. Operating margin judges the trading business alone, pretax margin adds the cost of how the business is financed, and net margin adds the tax outcome on top of both.
Managers favour the pretax version because tax is largely outside their control in any given year, distorted by prior year losses, one off credits and changes in the statutory rate. Judging a divisional team on a number that swings with tax legislation is neither fair nor useful.
Calculating it takes seconds from any profit and loss account: find the line labelled profit before tax and divide by total revenue. The discipline lies in using the same revenue definition every time, since gross sales, net sales after returns and revenue including other income can produce noticeably different answers.
Watch for one off items sitting inside pretax profit, such as a gain on selling a building or a large legal settlement. Most analysts strip these out to get an underlying margin, because the ratio is meant to describe the ongoing business rather than a single lucky year.
In practice
Real-world examples.
Example
A distribution business improves its pretax margin from 4% to 6% purely by refinancing expensive debt. Operating margin is unchanged, which tells the board the gain came from the balance sheet rather than from trading.
Example
Two competing recruitment firms both report net margins of 9%, but one operates in a jurisdiction with a much lower tax rate. Comparing pretax margins of 11% and 15% reveals that the second business is genuinely more profitable before tax effects muddy the picture.
Example
A food producer's pretax margin jumps from 7% to 14% in a year that included a $2,000,000 gain on selling surplus land. Analysts recalculate the margin excluding the gain, get 7.5%, and treat that as the real underlying figure.
Think of it
“Pretax margin shows profitability before taxes take their share-earnings margin before Uncle Sam.
Formula
Calculation
Pretax profit margin = (pretax profit / revenue) x 100
A packaging manufacturer reports revenue of $8,000,000 for the year. Cost of goods sold is $4,800,000, leaving gross profit of $8,000,000 - $4,800,000 = $3,200,000. Operating expenses of $2,100,000 bring operating profit down to $3,200,000 - $2,100,000 = $1,100,000.
Interest on its bank loans costs $140,000, so pretax profit is $1,100,000 - $140,000 = $960,000. The pretax profit margin is ($960,000 / $8,000,000) x 100 = 12%.
For comparison, the operating margin is ($1,100,000 / $8,000,000) x 100 = 13.75%, and the 1.75 percentage point gap between the two is entirely the cost of the company's borrowing.Case study
Seen in the real world.
This is an illustrative, fictional example. Sandgate Components, an invented supplier of machined parts, had spent three years celebrating a rising net profit margin without asking where the improvement came from.
Its finance analyst rebuilt the numbers using pretax margin instead and found the trading business had actually gone backwards: operating margin had slipped from 9.5% to 8.2%, while pretax margin had held at around 6% only because interest costs fell as an old loan was repaid. The apparent improvement in net margin came almost entirely from a lower effective tax rate after prior year losses were used up.
Once the illustrative board saw the split, it stopped treating the tax windfall as performance and refocused on pricing and factory efficiency. The tax benefit ran out the following year, and Sandgate would have faced an unpleasant surprise had it not already begun rebuilding trading margins.
Watch out
Common mistakes.
- Treating pretax margin as a measure of operational performance when it also reflects financing decisions such as how much debt the company carries.
- Comparing pretax margins across industries, where structurally different cost bases make a 4% margin excellent in one sector and dismal in another.
- Leaving one off gains and losses inside the calculation, which produces a margin that says nothing about the year ahead.
Questions
People also ask.
Why use pretax profit instead of net profit?
Tax rates vary by country, by year and by a company's history of losses, so removing tax gives a cleaner comparison of underlying performance.
Is pretax profit the same as EBIT?
Not quite, because EBIT excludes interest as well as tax, while pretax profit has already had interest deducted.
What counts as a good pretax profit margin?
It depends entirely on the sector, with grocery retail often running near 2% to 3% while software businesses can exceed 25%.
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