What is Profit Before Tax (PBT)? – Profit Before Tax Formula with Example

What is Profit Before Tax (PBT)? - Profit Before Tax Formula with Example
| Updated on: March 3, 2022

What is profit before tax?

Profit before tax or PBT is the gross profit that a business earns before income tax is applied. Other names of profit before tax include pre-tax profit and earnings before tax or EBT. The profit before tax value is found on the income statement which is generated either quarterly, half-yearly, or annually. The profit before tax value is used to determine how much tax the business has to pay based on its income. The profit before tax value is calculated based on a formula that takes into account the total revenue, operating expenses, interest expenses, and cost of goods sold.

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Significance of profit before tax

Profit before tax allows you to know and evaluate your profit margins. Profit margins allow you to understand the effectiveness of your ability to turn your revenue into profits. This is quite useful for the stakeholders of the business. Knowing the profit before tax value enables management to take valuable business decisions too. PBT also provides insight into how much tax will need to be paid by the business. Another benefit of the profit before tax value is that it is viewed along with the net profit and operating profit by the investors. This allows them to analyse your business and make decisions based on these values collectively.

Formula to calculate profit before tax

The profit before tax formula is as follows.

Profit before tax = EBIT – Interest expenses

Or

Profit before tax = Revenue – Cost of goods sold – Operating expenses – Interest expenses

Profit before tax example

Here is an example to show you how the profit before tax formula is calculated.

Fiscal Year Ended

Dec. 31 2021

Net Revenues

 

   Company-operated stores

$25,000

   Others

$3,500

Total Net Revenues

$28,500

Cost of sales

$9,000

Store operating expenses

$5,500

Other operating expenses

$500

Depreciation expenses

$1,500

General and administrative expenses

$2,000

Total Operating Expenses

$9,500

Operating income

$19,000

Interest income

$500

Interest expense

$250

Profit Before Taxes

$10,250

The first calculation that we must do is to calculate the profit before tax is the total revenue earned by the business. To calculate this, you need to add up the revenue earned from store or stores that you operate and other revenues that you directly earn from running your business. In this case, this would be $25,000 + $3,500 for the first column which equals to $28,500. If you have licensed stores, then you will add the revenue you earn from there to derive the total revenue.

Net Revenues

 

   Company-operated stores

$25,000

   Others

$3,500

Total Net Revenues

$28,500

The second calculation is the total operating expenses. In order to calculate the total, you need to add all the expenses associated with running the business. This includes running the store, depreciation expenses, and general and administrative expenses. Simply add up all the expenses and you have the total operating expenses. Let us calculate it for the first column. It would be $5,500 + $500 + $1,500 + $2,000 = $9,500.

Store operating expenses

$5,500

Other operating expenses

$500

Depreciation expenses

$1,500

General and administrative expenses

$2,000

Total Operating Expenses

$9,500

Next, we will calculate the other income that was earned. For example, in this case the business earned from interest income. Let us continue with the left column where the interest income is $500. Now, we have all the required calculations to come to the profit before tax value. So, using the formula PBT = Revenue – Cost of goods sold (or cost of sales) – Operating expenses – Interest expenses, we can see that:

PBT = $29,000 - $9,000 - $9,500 - $250 = $10,250

We added $500 to the total revenue because interest income was earned and so this should also be a part of the calculation. If there was any gain from other ventures then the value will be added to the revenue as well. In this case, the total profit before tax is $10,250.

Revenue

$28,500

Interest income

$500

Total Revenue

$29,000

Cost of sales

$9,000

Operating expense

$9,500

Interest expense

$250

Profit Before Taxes

$10,250

PBT vs. EBIT

The difference between PBT and EBIT will reveal the debt sensitivity of a business which can be vital for a business owner. Although on surface level, profit before tax and earnings before interest and tax seem similar, they are distinct in how they are calculated and their uses. Here are the top differences you should know between the two.

PBT

EBIT

PBT or profit before tax is the total profit a business makes before income tax is applied on the revenue. It takes into account the various revenue sources and operating expenses of the business along with the interest expenses. PBT is also called earnings before tax.

EBIT or earnings before interest and taxes measures total profits without the expenses. It doesn’t take into account the interest expenses and tax applied on the income earned. EBIT is also called operating earnings, operating profit, or profit before interest.

Profit before tax is not a good measure to compare two or more businesses because the nature of their operations can differ which will give a skewed comparison results if they are compared. Hence, it is best for comparing a single business with its past performance.

Earnings before interest and tax is useful when it comes to debts for businesses that require capital. It also enables businesses to compare themselves with other businesses that operate in the same industry and that have to pay tax differently.

PBT is the taxable income on your income statement. It enables businesses to understand how well revenue is turned into profits and whether they are reaching their goals in that area. This allows the management to take decisions to increase profits and opt for strategies that improve profits.

EBIT is the operating income on your income statement and it throws light on the operational capabilities of your business. This allows you to better understand your full operational potential and then make decisions based on the EBIT value.

PBT is calculated by adding the total revenue and then subtracting the expenses including interest expenses. If you have already calculated EBIT then you can calculate PBT by subtracting interest expenses from EBIT to get a profit before tax value. 

EBIT is calculated by using the total revenue and then subtracting the cost of goods sold and the operating expenses from it. Or you can say that EBIT is the same as gross profit minus the operating expenses.

PBT calculation has a limitation too and it is that it cannot be used by itself to determine the business performance. For example, profit before tax does not give any indication of the bottom line of companies which makes it difficult to compare businesses.

EBIT’s limitation includes its inability to properly how the company’s earning potential. When a company has a lot of debt, the EBIT will show the earnings in inflated form because it isn’t taking the interest expense into account. This can be problematic if EBIT is being used solely.

TallyPrime: Track revenue and expenses with ease

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