Pretax Income [2024 Guide]: Examples, Formula, and Benefits

If employees have gross pay or the salaries they have earned before taxes, business owners have something similar called “pretax income.” Pretax income refers to the total amount earned by a business before taxes are deducted.

Calculating a business’s pretax income contributes to the assessment of a company’s intrinsic asset or value. In turn, the generated intrinsic asset of a company gives financial analysts and business owners a concrete idea of how their venture’s profitability compares to other establishments worldwide.

If you are interested in learning more about pretax income and how you can use it to evaluate the lucrativeness of your business, then this article is the perfect guide for you!

Read on to learn what pretax income is all about, how to calculate it, and what benefits and disadvantages it can bring to your operations!

Key Takeaways

• Pretax income is the net earnings of a business before taxes are deducted. It includes operating and interest expenses, depreciation, and interest income.
• Taxable income is the net income of a company after taxes. It shows the amount that is taxable from a business’s earnings.
• Pretax earnings are essential in measuring fiscal health, assessing profitability, and generating insightful financial data for a company.
• Earnings before taxes discount the impact of tax obligations on a company’s income, making it an incomplete basis for evaluating and predicting a business’s long-term lucrativeness and stability.

What is Pretax Income?

Pretax income, pretax earnings, or earnings before taxes are the total annual earnings of a business before taxes are subtracted from its income. While pretax earnings do not include the amount to be deducted for taxes, they do, however, take into account other business deductions such as salary, interest, and operating expenses.

Additional adjustments covered under pretax income are depreciation and other non-cash expenses, as well as interest payments.

Earnings before taxes are used to measure the financial performance of a company or business. The exclusion of tax liabilities makes way for a more precise measurement of a business’s profitability.

In the U.S. alone, state taxes have specific variations per jurisdiction. For instance, Alaska, Nevada, and South Dakota do not require employers to withhold state income taxes from their employees.

Since the differences in federal and state tax withholding regulations are omitted, it leaves an even field for comparing the income of various businesses.

Difference Between Taxable Income and Pretax Income

The key differences between taxable income and pretax income are as follows:

• Pretax income refers to the annual earnings made by your business before tax amounts are subtracted. Taxable income describes your annual business income after taxes are deducted.
• Taxable income provides a reference for the taxable amount of a company’s earnings. Pretax earnings are instrumental in measuring a business’s intrinsic value and calculating the taxes owed by your company.
• Pretax income is based on your marginal tax rate or the additional tax rate included for every dollar added to your regular income. Meanwhile, taxable income is based on the effective or average tax rate paid by your business to the government.

Pretax Income Formula

Use this pretax income formula to calculate your pretax earnings:

• Pretax income = Gross earnings − (Depreciation + interest expenses + operating expenses + interest income)

The formula focuses on your business’s gross earnings and accumulated expenses. It also takes into account the income that you have generated from other sources, such as your investments.

Gross earnings refer to the total income generated by your company. Depreciation is the decrease in your asset’s monetary value while operating expenses include all deductions for interest and amortizations.

Interest expenses encompass startup loans and mortgages, and interest income has to do with income generated by your business by lending your resources.

Pretax Income Example

Here is an example of pretax earnings to help illustrate how to calculate pretax earnings:

“XYZ Services” has generated the following in gross income and interest income:

• Gross income: $10,000,000
• Interest income: $380.00

Operating and interest expenses:

• Employee salaries and wages: $70,000
• Rent and repair costs: $13,000
• Cost of goods sold (COGS): $300,000
• Depreciation: $60,000
• Interest expenses: $1,580

Now, let’s apply the formula above:

$10,000,000 − ($380 + $70,000 + $13,000 + $300,000 + $60,000 + $1,580)

$10,000,000 − $444,960

According to the formula, XYZ Services’ pretax income is $9,555,040.

Why is Pretax Income Beneficial?

Knowing your pretax income proves advantageous for your business in the following areas:

#1. Provides Financial Standing Insight

Calculating your pretax earnings entails backtracking and calculating your operational and interest expenses, depreciation, interest income, and the cost of producing your goods. By closely watching your expenses and earnings, you gain a better sense of where your business stands financially.

You might find that your cost of goods sold is not as balanced as the profits you make in return. Or, you may be spending more money on renting and repairing office space instead of investing in more flourishing financial resources.

#2. Facilitates Clean Comparison of the Organization

Federal and state taxes are not included in accounting pretax income, meaning it reflects an organization’s expenses and profits as they are. When comparing the profitability of different businesses, it is always best to discount tax rates, considering how they may vary in terms of the company’s location and tax bracket.

Varying tax rates and regulations yield pretax earnings that do not show a company’s true intrinsic value.

#3. Makes Measuring Fiscal Health Easy

Speaking of a company’s true intrinsic value, take a closer look at how much you’ve spent and earned. In that regard, you can gauge your business’s current fiscal health and delve deeper into the factors affecting your budget and sales.

Regularly checking your business’s fiscal health is a must if you want to ensure your business has enough funds for your future marketing strategies. Also, tracking your business expenses enables you to review whether you are investing money for long-term stability or not.

#4. Accurately Assesses the Company’s Profitability

As you take a closer look at your pretax ratio, you gain an accurate assessment of your company’s progress profit-wise. A high pretax income percentage usually means that your business is doing well because it means you have a solid business model, a balanced sales and cost ratio, and strong market power.

Low pretax earnings usually mean you need to work on regulating your company’s expenditures and evaluating the value you assign to your products and services.

Disadvantages of Pretax Income

It’s all about balance in business. You can’t have all the benefits offered by pretax earnings without considering their disadvantages:

• Tax considerations are not included. Separating tax obligations from your expenses and earnings generates precise and insightful references for your financial health. However, your taxes are also just as essential in monitoring business performance since it entails your compliance in fulfilling your federal and state obligations.
• Pretax income ratio may significantly change once taxes are applied. It may increase or decrease your profitable value. This is something that you should look into to apply the necessary adjustments in your operations.
• Pretax earnings only represent one aspect of your business’s growth. It does not encompass the entirety of your company’s potential for expansion and tendency to lose market value amid changing industry trends. It is best to consider other aspects of business management, such as your target market, economic changes, and customer demands.

Final Thoughts

Business owners understand how to use the value of their pretax income to their full advantage. The financial standing provided by pretax earnings is merely scratching the surface of all the work required to sustain business operations and adapt to industry trends and customer expectations.

Whether you end up with a high or low pretax income percentage, you should use this information to figure out other possible opportunities to improve your market value and generate more revenue.