Among the many metrics for measuring a company’s profits is earnings before tax, also known as pre-tax earnings.
While it can be tricky to distinguish between pre-tax earnings and other metrics like operating income, net income, gross profit, and others, this guide will help clarify what this value is, what it says about a company’s finances, and how to calculate it in a few simple steps.
What is earnings before taxes (EBT)?
Earnings before tax (EBT) refers to the portion of profits that remain before accounting for tax payments.
EBT considers all operating and non-operating expenses, providing businesses with a measure of their financial performance and profitability to compare against historical values or industry peers.
The EBT is one of the final line items shown on the profit and loss statement before the net income, which accounts for the company’s tax obligations.
Key factors affecting EBT
Since EBT sits near the bottom of the income statement, there are numerous figures that affect its value.
As shown in the formula below, the key figures that affect pre-tax income include:
- Revenues
- Cost of goods sold
- Selling, general, and administrative (SG&A) expenses
- Depreciation & amortization
- Interest expense
Essentially the only line item on the income statement that does not impact EBT is taxes, as the name might suggest.
How to interpret earnings before taxes
To reiterate, pre-tax earnings represent a company’s profits after deducting nearly all expenses except taxes. In general, the higher the pre-tax earnings, the better, as it shows that the company was able to retain a good portion of its earnings over the period.
Companies often look to improve this figure over time, representing more efficient operations and lower financing costs.
At the same time, EBT is a key figure for determining what the company will owe in taxes for a given period since it represents its taxable income. So, as pre-tax profits grow, it generally means the amount of taxes owed will also increase.
How to calculate earnings before taxes (EBT)
Formula for earnings before taxes
The formula for calculating pre-tax earnings is relatively straightforward. In the simplest terms, EBT is equal to earnings before interest and tax (EBIT) minus the interest expense, or:
It’s possible to break the calculation down even further to represent the individual components that go into the EBIT formula, which is as follows:
When used correctly, both formulas should provide the same value for pre-tax earnings. So, there’s no real difference in choosing either option.
If the EBIT value is already known, the first formula will save some extra steps. Otherwise, the second formula might provide more clarity around the individual components that must go into the calculation.
Step-by-step guide to calculating EBT
The EBT equation is essentially a series of subtractions. However, since there are quite a few figures that are required to find EBT, it can be helpful to break the formula down into individual steps and understand the other metrics that are calculated in the process.
Step 1: Find the gross profit
The first step in the equation is to subtract the cost of goods sold from the top-line revenues, which is the company’s gross profit:
Step 2: Find the operating income
Next, subtracting the selling, general, and administrative (SG&A) expenses and depreciation and amortization from the gross profit provides the operating income:
This is also referred to as the earnings before interest and taxes, or EBIT.
Step 3: Find the EBT
Finally, to find the EBT or pre-tax income, subtract the interest expense from the EBIT value:
Tips and considerations for accurate EBT calculation
Again, the formula for calculating EBT is not too complex, though there are plenty of moving parts to the equation that might provide some room for error or confusion.
Here are some helpful tips for accurate EBT calculations:
- Maintain accurate financial records: The accuracy of pre-tax earnings calculations depends on the soundness of the company’s financial records. If the income and expenses are not recorded properly, then the EBT calculation will also be inaccurate.
- Use the right tools and software: A dedicated accounting or financial management software system can make it easier to find this figure by conveniently storing all relevant and up-to-date financial data in one place, and reducing the need for manual calculations.
Example of EBT
Real-world scenario of an EBT calculation
Consider XYZ Inc. recorded the following financial performance for the final quarter of 2024:
- Revenue: $450,000
- Cost of goods sold (COGS): $55,000
- Wages and salaries: $95,000
- Maintenance costs: $4,000
- Administrative expenses: $65,000
- Interest expense: $3,500
- Depreciation and amortization: $7,000
Using the second formula, we can find the pre-tax income with the following steps:
Pre-tax earnings = $450,000 – $55,000 – $95,000 – $4,000 – $65,000 – $3,500 – $7,000
= $220,500
Comparing EBT across different companies or industries
Pre-tax earnings are an important line item on a company’s income statement and provide a key way for businesses to compare current performance against historical earnings and other companies within the same industry.
Using EBT to assess company performance over time
Companies may be interested in assessing pre-tax earnings in the current period to previous periods.
It allows them to monitor how their earnings have improved or contracted over time, regardless of changes in their effective tax rate.
Comparing EBT with industry benchmarks
Internal and external stakeholders may also be interested in using the pre-tax income as a way to compare a company against industry peers and benchmarks.
Even companies within the same industry can face much different tax rates depending on where they operate, available incentives, and other factors. Thus, using the pre-tax income provides a much more direct way to compare companies’ profitability and operational efficiency without needing to account for the variability of income taxes.
Limitations of using EBT for comparison purposes
Even though most companies strive to maximize pre-tax earnings, this figure can vary significantly depending on the stage of growth, seasonality, industry, and other factors. Thus, it’s not always the best metric for representing whether a company is performing “well” or “poorly” compared to others.
For instance, companies in the early stages of growth may have lower, or even negative pre-tax earnings, while a more mature enterprise will have much higher EBT by comparison. Plus, companies may experience seasonal variability, with some periods having much lower EBT than in peak demand periods.
This figure offers one way to gauge a company’s operations to others, but it can be misleading if it’s the only form of comparison.
Maintain accurate earnings records with BILL
Earnings before tax is a straightforward yet important metric that internal and external stakeholders will monitor to assess a company’s financial performance and drive strategic decisions.
The formula is quite simple, though as mentioned above, accurate EBT calculations depend on accurate financial records for earnings and expenses, which is where an integrated financial operations platform like BILL can help.
Using BILL, you’ll have more control and transparency of payables, receivables, and expenses from one location, which can seamlessly sync to your accounting software to ensure your records remain accurate and up-to-date.
Sign up for a free trial of BILL today to see how automating your financial workflows can help your team get paid faster and spend less time on repetitive tasks.
