Profit Before Tax

Significance of PBT

The significance of PBT can be understood by interpreting the following attributes:

1. Interpretation of Company

   PBT allows shareholders of a company or organisation to measure the growth rate of a company after evaluating the earning before tax.

2. Potentiality of Organisation

   The stakeholder or a company evaluates the PBT to analyze the efficiency of a firm to convert the revenue into profit.

3. Comparisons

   PBT allows the shareholders to draw several comparisons about the organisation by evaluating the PBT over several years. For example, the shareholders can interpret the rise and fall of an organisation by taking into consideration the PBT of the last five to ten years. 

   Similarly, the investors can also determine whether to stay or leave the organisation if it does not fetch extra profits. On top of that, the stakeholders can also draw comparisons between different firms and companies by reviewing their PBTs. 

4. Competency

   The investor can determine the competency of an organisation to generate profits for shareholders after paying the tax. They can also calculate their interest upon deduction of the tax rate. 

5. Control of Finance

   The PBT allows organizations to determine if they need to investigate finances if the company generates less than expected profits.

PBT Formula 

The PBT formula is necessary to calculate profit before tax. 

One can follow the below-mentioned steps to calculate the PBT:

1. Financial Data

   A company must gather or collect financial data on the income earned by the company. It is because the revenue of an organisation comes from different sources. It is essential to analyze income from various sources, such as rental income, sales income, and income from other sources. 

2. Evaluation of Expenses

   To earn an income, a business is subject to make several expenses. Therefore, the business needs to calculate the expenses incurred in the operation of the organisation. The expense includes debt, rent, utilities, and the cost of goods sold. It further consists of the wages that have been paid and which are yet to be paid, along with the health and charitable contribution. 

3. Subtraction

   The deductible expenses need to be subtracted from the earned income to evaluate the profit before tax.

   For which, the formula for PBT is: 

   Profit before tax = Revenue - Expenses

   It is important to note that the expense does not include the tax rate. Hence, the assessor should avoid levying tax rates on profits. The tax rate is added to calculate the profit after tax. 

Illustration of PBT formulae:

Let us understand the calculation of profit before tax with an example.

An ABC limited has INR 12,00,000 in sales during an assessment year. It incurred INR 2,00,000 on the cost of goods sales. Further, it claimed depreciation of INR 1,00,000 on the machinery, furniture & fixtures and other tangible assets. 

Further, incurred a cost of doing business of INR 1,50,000 during the same year. Therefore, the interest expense is determined as INR 50,000. Thus, the company wishes to measure the PBT.

From the aforementioned data, one can fetch the following:

• Revenue = INR 12,00,000 (Total sales)

• Depreciation = INR 1,00,000

• Cost of Goods Sold = INR 2,00,000

• Cost of Doing Business = INR 1,50,000

• Interest Expense = INR 50,000

Assessor needs to apply the formula: 

Profit before tax = Revenue - Expenses to calculate the PBT

First, one must evaluate the revenue and expenses to proceed further. 

From the above context, one may evaluate the following:

Revenue = INR 12,00,000

Expenses = INR (2,00,000 + 1,00,000 + 1,50,000 + 50,000)

= INR 5,00,000

Profit before tax = Revenue - Expenses

= INR 12,00,000 - 5,00,000

= INR 7,00,000

Hence, the tax shall be applied to INR 7,00,000.

Importance of PBT

• One can determine the growth and capabilities of an organisation by interpreting the PBT. In addition, employers can also determine the internal and external management of their organisation and comprehend the financial development and data of the firm. 

• The stakeholders or investors may evaluate the take-home profit upon levying the tax rate on the PBT. 

• To evaluate PAT (Profit After Tax), it is essential to determine the PBT (Profit Before Tax). 

• After evaluation of the PBT of a firm, the management may draw comparisons against the operation of different firms of the same industry. They may analyze if their technique is up to the mark or need changes. In addition, they may discover several alternatives they need to adapt upon determining the PBT. 

• The company is likely to attract more investors if the PBT is higher than the previous years. But, at the same time, it may lose them if the PBT is declining. 

• The investor may agree to more allocations of their financial assets. For example, if the PBT competes financially with other organizations in the same industry, the shareholders are likely to buy more shares. On the other hand, they may reallocate if the organisation does not perform well.

Benefits of PBT

• PBT shows the performance of a company during a financial year. It reflects its financial stability among other companies. 

• PBT is opposed to PAT. So it can measure the performance more efficiently. 

• The company may determine its debt obligation after evaluating PBT. 

Disadvantages of PBT

• It does not give an accurate account as the profit has yet been taxed. 

• Tax rates are not alike in every nation. Hence, the final profit might be distinct.

Final Words

Profit before tax refers to the total earning of an organization before discharging its tax liability. Every organization is bound to calculate the PBT to pay taxes. PBT is utilized to compare the profitability of the firm. Further, one may calculate PBT by applying its formula.

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