Profit Before Tax Definition
Profit before tax (PBT) is a line item in the income statement of a company that measures profits earned after accounting for operating expenses like COGS, SG&A, Depreciation & Amortization, etc as well as non-operating expensesNon-operating ExpensesNon operating expenses are those payments which have no relation with the principal business activities. These are the non-recurring items that appear in the company's income statement, along with the regular business expenses. like interest expense, but before paying off the income taxes. This is a significant measure because it gives the overall profitability and performance of the company before making payments in corporate taxesCorporate TaxesCorporate tax is a tax levied by the government on the profits earned by a company at a fixed rate each year and is calculated in accordance with specific tax regulations..
PBT is further used to calculate net profits by deducting income tax.
The formula of Profit Before Tax
PBT can be simply calculated by the following formula:
An income statement that starts with revenue or sales goes on to calculate PBT as follows:
Format of Profit Before Tax
Revenue or Sales
Less: Cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.
Less: Operating expense
Less: Interest expense
This is a simple format for PBT calculation and can vary in complexity.
Examples of Profit Before Tax
Below are some examples of PBT
Company XYZ limited has the US $12 million in Sales and wants to measure its PBT. The table below gives insight into different costs/expenses.
From the above data, we get the following information.
- Revenue: 12,000,000
- Cost of Revenue: 7,500,00
- Depreciation: 550,00
- SG&A: 2,200,000
- Interest Expense: 800,000
Subtract Cost of revenue to get Gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services..
Gross Profit will be –
- Gross Profit = 4500000
Therefore, the calculation of PBT as per formula
- = 4500000-550000-2200000-800000
- PBT = 950000
AAA Limited and BBB Limited operate in similar industries with similar scale and product linesProduct LinesProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.. A team of analysts wants to make a comparative analysis of the PBTs of these two companies, and they have the following information-
From the above data, we get the following information.
|Company||AAA Limited||BBB Limited|
|Cost of Goods Sold||$14,000,000||$14,800,000|
|Profit Before Tax||?||?|
|Income Tax Rate||30%||36%|
|Profit After Tax||?||?|
Calculation of Profit Before Tax
Therefore, the calculation of PBT of AAA limited as per formula is as follows,
- PBT = $5000000
Therefore, the calculation of PBT of BBB limited as per formula is as follows,
- PBT = $4700000
Calculation of Profit After Tax
Therefore, the calculation of PAT of AAA limited as per formula is as follows,
- PAT = $3500000
Therefore, the calculation of PAT of BBB limited as per formula is as follows,
- PAT = $3008000
This shows that while profit before tax measures performance, it does not reflect correctly on the profitability. PBT, on the other hand, better gauges profitability but falls short of giving insights on parameters like productivity, efficiencies, and performance levels.
Advantages of PBT Measure
Companies with similar business, characteristics, and scale can be analyzed on a comparative basis with regard to their Profits before tax:
- PBT can mislead companies’ comparative performances because of its subjectivity to different tax systems. Hence, a preceding line item, PBT, better takes into account the comparability by eliminating the varied nature of taxes.
- PBT, as opposed to PAT (Profit after tax), is a measure of performance. In the situation of varied tax policies, PAT is more inclined toward profitability calculationProfitability CalculationProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. than performance measurement.
- Profit before tax also acknowledges the debt obligations of a company. The long-term debtLong-term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability. and lease obligations in the balance sheet of a company are reflected in the interest expense column of its income statement.
Disadvantages of PBT Measure
- Profits that are not taxed do not give a true account of companies’ free cash flows (FCFFCFThe cash flow to the firm or equity after paying off all debts and commitments is referred to as free cash flow (FCF). It measures how much cash a firm makes after deducting its needed working capital and capital expenditures (CAPEX).). This makes for a skeptical valuation of a company if FCF methods are used.
- PBT, by itself, is not a complete measure for comparison purposes if the operations of companies under consideration are not similar – in nature and scale.
Limitation of PBT as a Measure of Profitability/Performance
Although PBT gives a clear picture of how companies have performed in terms of their sales, and costs, both operating and non-operating, it becomes difficult to gauge the bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. of companies operating in different business settings.
- Taxation policies vary significantly across the world.
- The company’s profits might be eligible for tax benefits.
These conditions make a substantial difference in companies’ bottom line and redefine profitability if not performance.
Significance of PBT and Points to Note
While there are many other factors based on which the performance of a company can be evaluated, Profit before tax becomes important because it takes note of all the expenses incurred by the company. As we go into finer details, the analysis becomes better and provides greater insights into the health of the business.
However, any analysis that overlooks qualitative factors concerning the business is incomplete. For that matter, even Profit after taxProfit After TaxProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business. will be rendered futile if analysts neglect the qualitative analysis of the company. It should be made a point that companies are not evaluated on the numerical values of their respective PBTs. Underlying assumptions and reasons are equally important to draw near-complete analyses of companies.
Profit before tax can also represent as Earnings before tax:
Earnings before tax, EBT = EBIT – interest expense = PBT
PBT is an important concept in business. It measures business performance in so far as everything except taxes. Unlike gross profit and operating profit where all the expenses are not included, PBT analysis should always consider different expense recognition principlesExpense Recognition PrinciplesThe Expense Recognition Principle is an accounting principle that states that expenses should be recorded and compiled in the same period as revenues. followed by different businesses.
A company’s interest payments will capture its high leverage and give analysts a true picture of its indebtedness. While PBT is a good measure of this indicator, EBITDA and EBITEBITEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital. fail to sense the same.
From the perspective of an investor, PBT is a useful measure for comparing businesses located in different economies, thus subject to different taxes. The extent to which PBT reflects performance in such cases is probably the finest of all – Sales, EBITDA, and EBIT.
This has been a guide to Profit Before Tax and its definition. Here we discuss formula to calculate PBT along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –