Profit Before Tax

Definition of Profit Before Tax

Profit before tax (PBT) can be defined as a derived component of an income statement that calculates and presents the profits earned during an accounting period after taking into consideration items like revenue and operating costs such as cost of goods sold, general selling, and administrative expenses, amortization and depreciation, also all other non-operating income and expenses like interest before considering income tax expenses for that period.

Explanation

PBT is a calculated item of profit and loss a/c that sums up and presents the company’s profits, including all elements like operating, non-operating, seasonal operations, and continuous operations-related revenue and costs. It is an important measure depicting the organization’s profit-earning capacity as tax expenses constantly fluctuate. Therefore, eliminating it will help an investor have a better idea of changes in the company’s earnings from year to year. Profit before tax is also known as profit before tax or pre-tax profits. Profit before tax is listed in the profit and loss account mostly in the third to last line; the second is the tax expenses, and the last is the company’s net profit. This is because the company pays taxes at different rates depending on its location; profit after tax may not adequately justify its earning capacity, and PBT is treated as the mirror of a company’s profitability. Therefore, it is often expressed as a percentage of revenues, which shows how much each dollar of revenue earned is transformed into profit before tax.

Formula for Profit Before Tax

The formula for a profit before tax is given below:

PBT = Revenue from Operating Activities + Revenue from Non-Operating Activities – Cost of Goods Sold – Operating Expenses – Non-Operating Expenses

OR

PBT = Net Income + Income Tax

• Revenue from operations: Income earned from normal business activities of the company in the normal course of time.
• Revenue from non-operating activities: Income earned from sources that do not form part of core business activities -like sale of assets, interest income, dividend income, etc.
• Cost of goods sold: The cost incurred directly in making the product like material, labor, etc.
• Operating expenses: Expenses that are incurred to run and maintain the business in a normal course. These expenses cannot be avoided.
• Non-Operating expenses: These are the expenses that do not form part of the normal business-like loss on the sale of an asset, interest expense, commission, etc.

How to Calculate Profit Before Tax?

PBT is the net inflow considering all accrued income irrespective of its source, whether operating or non-operating, like sales, revenue from services, commissions, interest income, dividend income from extraordinary transactions, etc. Also, after deducting all the expenses except the corporate income tax.

To calculate the profit before tax, these steps must be followed.

• Step 1: Gathering of all financial data about income earned by the company – Under this step, the information regarding the income of the company must be gathered as the money received from the normal course of business, money received from other sources like rent received, discounts received, interest received, dividend received, income from the sale of an asset, etc. these all incomes must be added together to form the total revenue of the business. Please note that cash collected and all such revenue accrued over the accounting period will be considered.
• Step 2: Deduct the cost of goods sold – All the costs must be determined and deducted from the total revenues. Cost of goods sold included direct material, labor overheads, etc.
• Step 3: Derivation of operating profit – This step involves the reduction of operating expenses that are incurred in the normal running of business-like depreciation, amortization, rent, utility payment, etc., from total revenue made.
• Step 4: Deduct non-operating expenses – Under this step, all the expenses which are not part of the normal business activity, like interest, any loss due occurred due to fire, theft, etc., must be deducted from the figure obtained in step 3.
• Step 5: The figure obtained above is the profit before tax.

Example of Profit Before Tax

From the following mentioned below are the details of Amazon Inc. sales revenue of $1,00,000, cost of goods sold of $40,000, selling and general expenses of $10,000, depreciation and amortization$2,000 other expenses of $15,000, an interest charge of $5,000. Non-recurring income $20,000. Income tax expenses $5,400

Determine profit before tax for the period.

Solution:

Profit before tax can be derived as follows: –

PBT = Revenue from Operating Activities + Revenue from Non-Operating Activities – Cost of Goods Sold – Operating Expenses – Non-Operating Expenses

Particulars	Amount ($)
Sales Revenue	1,00,000
Cost of Goods Sold	40,000
Gross Profit	60,000
Less:- Operating Expenses
Selling and General Expenses	10,000
Depreciation and Amortization	2,000
Other Expenses	15,000
Total Operating Expenses	27,000
Operating Profit	33,000
Add:
Non-Recurring Income	20,000
Earning Before Interest and Tax	53,000
Less: Non-Operating Expenses
Interest Expenses	5,000
Profit Before Tax	48,000

Therefore, the profit before tax of Amazon Inc is $48,000. Income tax expenses are not considered for PBT calculation; therefore, $5,400 expenses are ignored.

Importance of Profit Before Tax

It is one of the most important indicators of a company’s performance as it takes notes of all the expenses incurred by the company. It provides external and internal stakeholders information regarding performance during an accounting period. As it excludes tax which could make data non-comparable in a different state, the country might have a different taxation structure. Therefore, PBT becomes a better source of performance indicator. Profit before tax depicts actual accrued profits, whether realized in cash or not. Various stakeholders widely use this term to conduct financial statement analysis, trend analysis, determine a company’s growth performance, etc.

Advantages

Some of the advantages are given below:

• It helps companies analyze the businesses with the same characteristics, businesses, and scale on a comparative basis.
• Profit after tax can mislead an organization’s comparative performance due to its subjectivity to different tax systems, and therefore PBT emerges as a better analysis medium.
• It is more inclined towards performance measurement rather than profitability calculation.

Disadvantages

Some of the disadvantages are given below:

• PBT is not a restorative measure for comparison purposes if the business’s operations are not similar in nature and scale.
• It does not consider tax, which may mislead the statements as the company’s profits may be eligible for the tax benefits.
• Also, it does not reflect on cash profits generated during the accounting period. Sometimes, the organization may be more interested in knowing its cash position than profitability.

Conclusion

Profit before tax is an important financial terminology. It considers every transaction accounted for during an accounting period except a tax for measuring business performance. PBT analysis always considers different expense recognition principles in different businesses. For an investor, profit before taxes is an important measure of comparing business performance under different economic conditions with different tax rates. Although other financial measures are more commonly used, like PAT, EBIT, and operating profit, depending on the requirement, the interested stakeholder may use PBT for their calculations.

Recommended Articles

This is a guide to Profit Before Tax. Here we also discuss the definition and how to calculate profit before tax? Along with advantages and disadvantages. You may also have a look at the following articles to learn more –

1. Earnings Before Interest and Tax
2. Deferred Tax Liabilities
3. Flat Tax
4. Excise Tax