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What is Profit Before Tax: Calculation, Advantages & Disadvantages

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What is Profit before tax?

Profit before tax or earnings before tax is the indicator to assess a corporation's profit before tax payment. A company mentions it in its income statement, and its purpose is to evaluate the profitability of a company without considering tax expenses. Interested individuals can keep scrolling to know more about this concept.

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How to Calculate Profit Before Tax?

Follow the step-wise guide mentioned below to calculate profit before tax:

Step 1: Arrange the Financial Information About the Company's Sources of Income
- This comprises overall sales, rental income, interest made on bank accounts, income after rendering services, discounts received, etc.
Step 2: Compute the Deductible Expenditures
- Company owners need to consider the expenditures to operate a business, such as debt, rent, unpaid wages, expenses for selling goods, donations to organisations for charity, etc.
Step 3: Deduct the Company's Deductible Expenditures from Its Income
- Deducting deductible expenses from income will provide the profit before tax.

So, the formula of profit before tax is as follows-

Profit before tax = revenue – expenses (excluding income tax obligations)

To make this concept easier for readers, here is an example using the formula of profit before tax:

Suppose Rai Services Pvt. Ltd. earns an operating revenue of ₹2,500 crores while its income from other sources is ₹500 crores. So, the total revenue is ₹3,000 crores.

It purchased raw material of ₹800 crores and had ₹100 crores as stock-in-trade. Moreover, the cost of changing inventory of finished and unfinished goods is ₹100 crore, and expenses including amortisation and depreciation amount to ₹200 crores. Other expenses include – employee benefits (₹500 crores), financing costs (₹100 crores), other tax expenditures (₹300 crores) and additional expenditures (₹200 crores).

So, the total cost of running a business before paying tax is ₹2,000 crores.

Therefore, the calculation of profit before tax is as follows:

Particulars	Amount
Total revenue	₹3,000 crores
Total expenditure	₹2,000 crores
Profit before tax (₹3,000-₹2,000) crores	₹1,000 crores

So, the pre-tax return on sales is 26.67%. This implies that Rai Services Pvt. Ltd. is generating earnings before tax of Rs. 26.67 for each ₹100 of its overall revenue.

Pre-tax returns is the total surplus revenue generated over incurring non-operating and operating expenditures, except tax expenses. It is evaluated by dividing EBT by the total revenue generated by a company.

What Are the Advantages of Profit Before Tax?

Take a look at the following advantages of profit before tax:

Profit before tax considers the debt liability of a corporation.
PBT is an essential performance indicator of a company.

What Are the Disadvantages of Profit Before Tax?

Here are the disadvantages of calculating profit before tax:

Every business operation is of a different type and varies in scale. Hence, PBT is not an accurate indicator of comparing business operations of multiple companies.
PBT makes it challenging to assess companies' net income functioning in varying business environments.

It is crucial to understand the vital aspects of profit before tax. This is because it is an essential determinant for shareholders and other investors willing to invest in stocks of a company. Besides, it allows business owners to assess the profitability of a business venture.

Frequently Asked Questions

All

What is the primary difference between profit before tax and earnings before interest and taxes?

The primary difference between profit before tax and earnings before interest and taxes is that the former denotes a company's taxable income. At the same time, the latter implies a company's operating revenue.

Does profit before tax provide an estimate of the free cash flow of a company?

No. One of the disadvantages of profit before tax is it does not provide the actual estimate of the free cash flow of a company.

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