Earnings Before Tax (EBT): Definition & Guide
Unfortunately, calculating business income isn’t as simple as goods sold = profit.
When calculating your earnings there is a lot more to take into consideration. This is especially important when you’re going over your tax return and calculating your earnings before tax.
But what exactly are earnings before tax? And how is it calculated? We’ll take a look at this and more.
Here’s What We’ll Cover:
What Is Earnings Before Tax (EBT)?
Earnings Before Tax measures a company’s financial performance. It is essentially a calculation of a business’s earnings before your relative tax rates are subtracted from the total.
The calculation used is sales revenue minus expenses, before taxes are taken into account. It is a line item on a business’s income statement just before the net income line.
A company's EBT will show the total earnings minus the company's costs. These costs would include the cost of goods sold (COGS), interest, depreciation, general and administrative expenses and other operating costs.
Looking at a businesses earnings before tax figures can be an interesting and useful metric. It is especially useful for comparing operating performance. This is because it removes the variable of taxes which can fluctuate and change over time. This means that looking at the after tax earnings can give you a skewed view of the overall core operations of a business.
Earnings Before Tax In Practise
It is a relatively straightforward calculation to figure out your EBT. Let’s put it to an example:
If a computer company sells 30 computers for £1,000 each in a single month then their sales revenue for that period would be £30,000.
The company would then look at its COGS and take that number away from the £30,000 revenue. So if the cost to create a single computer is £100, then its COGS for that month would be £3,000. That means its gross revenue is £27,000 which is the £30,000 income minus the £3,000 cost of goods sold.
Once the gross revenue has been calculated, the business would then tally all of its operating expenses. They would then subtract that figure from the gross revenue. An example of operating costs could include wages, rent, tools and any other overhead expenses.
As a hardware company would need highly skilled workers, then their wages for the month may total £10,000 with a monthly rent of £1,000. That would mean that the operating expenses would be £11,000 which would be subtracted from the gross revenue of £27,000 leaving you with a total of £16,000.
If we were to imagine that these were the only further expenses then the earnings before interest and taxes (EBIT) would also equal £16,000. If the company then had £1,000 of monthly interest expenses then the total Earnings Before Tax would be a total of £15,000.
Advantages and Disadvantages of Looking at Your EBT
There are a number of advantages and disadvantages to keeping a close eye on your EBT. Here are some examples:
- Budgeting: You can adjust your budget based on your gross revenue. Knowing this number can help you to make smarter purchasing decisions.
- Filing Taxes: When filing your taxes, it’s far easier when you know your gross annual income. This can help you figure out how much tax you owe or how much you’ll receive back. These financial statements can be a huge help to any business.
- Evaluate Performance: Your EBT can help provide you with an indication of how well your business is performing financially. This analysis can clearly show the effectiveness of your operational performance.
There is really only one disadvantage when it comes to knowing your EBT.
- Inaccurate Perception: When you look at your earnings before taxes are subtracted, you can get a skewed view of your income. It can seem like you are making more than you actually are which can be dangerous.
Working out your Earnings Before Tax is an important part of running your business.
This process becomes much easier when you utilise accounting software such as FreshBooks. Their software allows you to keep track of all of your business expenses which makes things far easier when you’re filing your income taxes. Having a clear and organised income statement will also allow for easier long-term growth.
Are you looking for more business advice on everything from starting a new business to new business practices?
Then check out the FreshBooks Resource Hub.