how pretax earnings work
a company s pretax earnings provide insight into its financial performance before the impact of tax is employed some consider this metric a better measure of performance than net income because certain factors such as tax credits carryforwards and carrybacks can have a bearing on a company s tax expenses in a given year pretax earnings are calculated by subtracting a firm s operating expenses from its gross margin or revenue operating expenses include items such as depreciation insurance interest and regulatory fines for example a manufacturer with revenues of 100 million in a fiscal year may have 90 million in total operating expenses including depreciation and interest expenses excluding taxes in this case pretax earnings amount to 10 million the after tax earnings figure or net income is computed by deducting corporate income taxes from pretax earnings of 10 million businesses may prefer tracking pre tax earnings over net income as items such as tax deductions and employee benefits paid in one period may differ from another period in effect the pre tax earnings are viewed as a more consistent measure of business performance and fiscal health over time because it erases the volatile differences brought on by tax considerations 1pretax earnings marginpretax earnings are used by analysts and investors to calculate the pretax earnings margin which provides an indication of a company s profitability the pretax earnings margin is the ratio of a company s pre tax earnings to its total sales the higher the pretax profit margin the more profitable the company 2for example assume company abc has an annual gross profit of 100 000 it has operating expenses of 50 000 interest expenses of 10 000 and sales totaling 500 000 the pretax earnings are calculated by subtracting the operating and interest costs from the gross profit that is 100 000 60 000 40 000 for the given fiscal year fy the pretax earnings margin is 40 000 500 000 8 but company xyz which has 750 000 in sales and 50 000 in pretax earnings has a higher profitability than company abc in dollars however xyz has a lower pretax earnings margin of 50 000 750 000 6 7 pretax earnings vs taxable incomethe pretax earnings are shown on a company s income statements as earnings before taxes it is the amount on which the corporate tax rate is applied to calculate tax for financial statement purposes pretax earnings are determined using guidelines from the generally accepted accounting principles gaap taxable income on the other hand is calculated using tax codes governed by the internal revenue service irs it is the actual amount of income on which the corporation will pay income tax during the accounting period 3