What Are Pretax Earnings?
Let me explain pretax earnings directly: they're a company's income after you've deducted all operating expenses, including interest and depreciation, from total sales or revenues, but before subtracting income taxes. Since they exclude taxes, pretax earnings let you compare the core profitability of companies across different industries or regions where corporate taxes vary. For example, U.S. corporations deal with uniform federal tax rates, but state-level taxes differ significantly.
You might also hear them called pretax income or earnings before tax (EBT).
Key Takeaways
- Pretax earnings are what's left of a company's income after deducting all operating expenses, including interest and depreciation, from total sales or revenues, but before subtracting income taxes.
- Pretax earnings give you insight into a company's financial performance without the influence of taxes.
- Many view pretax earnings as a more accurate gauge of business performance and health over time.
How Pretax Earnings Work
Pretax earnings show you a company's financial performance before taxes come into play. Some argue this is a superior measure compared to net income because elements like tax credits, carryforwards, and carrybacks can skew a company's tax expenses in any given year. You calculate pretax earnings by subtracting operating expenses from gross margin or revenue—these expenses cover things like depreciation, insurance, interest, and regulatory fines.
Take a manufacturer with $100 million in revenues for a fiscal year and $90 million in total operating expenses (including depreciation and interest), excluding taxes: that leaves pretax earnings at $10 million. From there, you get net income by deducting corporate income taxes from those $10 million pretax earnings.
Businesses often track pretax earnings instead of net income because items like tax deductions and employee benefits can fluctuate between periods. Essentially, pretax earnings provide a more stable view of business performance and fiscal health over time, as they remove the inconsistencies introduced by tax variables.
Pretax Earnings Margin
Analysts and investors use pretax earnings to figure out the pretax earnings margin, which signals a company's profitability. This margin is simply the ratio of pretax earnings to total sales—the higher it is, the more profitable the company.
Consider Company ABC with an annual gross profit of $100,000, operating expenses of $50,000, interest expenses of $10,000, and sales of $500,000. Subtract the operating and interest costs from gross profit: $100,000 minus $60,000 equals $40,000 in pretax earnings. For that fiscal year, the pretax earnings margin is $40,000 divided by $500,000, or 8%.
Now look at Company XYZ with $750,000 in sales and $50,000 in pretax earnings: it has higher profitability in absolute dollars than ABC, but its pretax earnings margin is lower at $50,000 divided by $750,000, or 6.7%.
Pretax Earnings vs. Taxable Income
On a company's income statement, pretax earnings appear as Earnings Before Taxes—this is the figure used to apply the corporate tax rate for financial reporting. It's determined following Generally Accepted Accounting Principles (GAAP). In contrast, taxable income is based on Internal Revenue Service (IRS) tax codes and represents the actual income amount a corporation pays taxes on during the accounting period.
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