What is pretax income?

Pretax income refers to the amount of earnings made by an individual or entity before any tax is deducted.

For companies, pretax income is the total earnings after operating expenses, interest, and other costs are subtracted, but before any corporate taxes are levied. It appears on a company's income statement as earnings before tax (EBT). The basic formula for calculating pretax income is:

Pretax Income = Revenue – Operating Costs – Interest – Depreciation

For individuals, pretax income is the gross income earned before taxes, Social Security, and pension contributions are deducted.

Pretax income vs. other financial metrics

Pretax income is often confused with other financial concepts linked to income. These include:

• Revenue: Also known as the top line, this is the total amount a company has earned before any expenses are accounted for
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): While pretax income subtracts all expenses before tax, EBITDA retains interest, taxes, depreciation, and amortization, and only subtracts other expenses
• Net income: This is the amount of income left after all relevant taxes and deductions are subtracted

Why is pretax income important for businesses?

For businesses, pretax income is a measure of performance that helps evaluate the company's financial health, assess liabilities, and develop long-term strategies.

Broadly, pretax income is used by finance teams to:

• Track growth: Understand how the company's profits change over time and whether financial performance is stable, strengthening, or weakening
• Compare across markets: Evaluate performance across markets where different tax regimes might be in place
• Make investment decisions: Assess the operational viability and risk of specific projects and initiatives to determine where resources are best allocated
• Optimize tax strategy: Use pretax income to track tax liability, time expenses, and leverage tax breaks to maximize after-tax profit

Why does pretax income matter to payroll?

Pretax income is an essential metric in payroll. In the US, it’s the starting point for determining an employee’s take-home pay and the size of their contributions to tax, Social Security, Medicare, and various benefits such as retirement plans (401(k) or 403(b)) and health savings accounts (e.g., flexible spending accounts (FSAs)). These payments are deducted before income tax, reducing the overall taxable income.

HR professionals need to stay on top of changes in legislation to ensure taxes and other payroll obligations are correctly calculated from pretax income.

What pretax metrics are used to analyze business performance?

There are several metrics linked to pretax income that analysts and investors use to evaluate performance.

Pretax earnings margin

Pretax earnings margin (or an EBT margin) is the percentage of the company's revenue that represents profit before any tax deductions are applied. The formula for calculating it is:

Pretax earnings margin = (Pretax income ÷ Revenue) × 100

The higher the pretax earnings margin, the more profitable a company is before taxes are applied. Because tax regulations vary across jurisdictions, this metric enables businesses to compare profitability across different markets and benchmark performance against competitors.

Year-over-year (YoY) pretax income growth

YoY metrics compare changes in a specific indicator from one year to the next. So, “YoY pretax income growth” measures how pretax income has increased (or decreased) compared to the same time last year. It’s calculated as follows:

YoY pretax income growth = (This year’s pretax income – Last year’s pretax income) ÷ Last year’s pretax income × 100

This provides insight into a company’s performance over time, helps build investors’ confidence, and supports budget planning by evaluating whether financial goals have been met.

Cost-to-revenue ratio

A cost-to-revenue ratio is a measure of a company's expenses relative to revenue. It's calculated as:

Cost-to-revenue = (Total costs ÷ Revenue) × 100

This measure is indirectly related to pretax income (which is the revenue after subtracting expenses). A low cost-to-revenue ratio typically means fewer expenses, higher pretax income, and a stronger pretax earnings margin.

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Managing payroll can be challenging, especially when working with distributed teams and employees located in different jurisdictions.

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