Profit before tax
Before we discuss after-tax income, let’s review what profit before tax means. Profit before tax is actually nothing more than the total company’s revenue after all expenses have been deducted, but before income tax has been subtracted. By revenue, we mean the total income the business has generated by selling goods or services that the company produces plus other income sources. Other income can be investments that a business receives profit from or gains it received from the sale of fixed assets. Total expenses are the cost of goods/services, operating expenses, depreciation, and other expenses.
Income before tax can be found on the company’s Income statement. Although this type of profit is not the company’s bottom line, it still represents a valuable indicator. Actually, if you are a long-term investor, you will most likely use the profit before tax to calculate your pre-tax return on investment. However, the taxes are an expense that can take a huge chunk of this profit from you. Let’s discuss what after-tax income is next.
What is your business going to receive after you pay all the taxes? The after-tax income on the Income statement is your quick answer. What does this value represent? It is the actual amount left in your company after paying the taxes based on the revenue generated by the company.
When looking at the company’s Income statement, you would want to see if its after-tax income is increasing or decreasing. If the company is not growing and its income is decreasing, you would obviously want to dig in deeper and see the reason why this is happening. Such a trend may indicate that a company has lower sales because the product is no longer in demand or needs better promotion or improvement or simply because the company is using old production equipment or has unqualified/unmotivated personnel.
It may also point to ineffective management of costs and other expenses, which take a big chunk of the revenue. Moreover, the reader of the financial statements might find that a company has large loans that it is still paying off and so on.
If this number is increasing over several periods, it is likely that the price per share of this company will also go up on the market. Keep in mind that like any accounting figure, the after-tax income can be manipulated. Hence, one should look at how it has been calculated before investing in a company or coming to any conclusions.
So, the after-tax income shows how profitable a company is. This is one of the most sought-after numbers when investors are determining what company to invest in. It helps to calculate the earnings per share of a company, reflecting how much each shareholder will receive for each share they own. In other words, after-tax income is the funds that the company pays dividends to its shareholders.
This is the money that is used to increase the working capital of the enterprise, for the formation of reserves, and also reinvestment in production, development, and other purposes. As was said before, having an after-tax income that is growing allows companies to pay good dividends to their shareholders. However, it can also choose to reinvest all or a portion of this income and grow and improve the business. This means that the investors are investing their money in the company again in hopes that these improvements and development will bring even greater income and, in turn, dividends for them.
A company with positive income growth is also in a better financial position to pay off debt. This means that when creditors are looking at the financial statements of such a company, they are more likely to lend in the first place and maybe offer better terms because the company is more likely to pay them back.
Finally, it is worth noting that the increase in the company’s net profit after taxes can be driven by a lower tax rate or a favorable tax regime. Investors should check the increase in the after-tax income against profit before tax to ensure that the additional income is related to increased profit and not better tax conditions.
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Just like any individual pays taxes when they receive a salary, wages, or any other type of income, so does the business. The amount of taxes a business owes to the government is also calculated based on the income it earns. The IRS sets the tax amount business owners have to pay from the business earnings, which is calculated as a percentage of these earnings or profit before tax we just discussed.
The first step in calculating the business income tax is to get the Corporate Tax Rate Schedule and find where your business’s profit before tax falls on that table. The corresponding tax rate will be used for the calculation. After you find the tax payment amount, you can calculate the after-tax income. You would calculate income after taxes by subtracting the tax liability from the net income before taxes.
What would be the after-tax income for Davis Inc. if you are given the following financial data?
- Sales: 18,600 units for $12 per unit
- Variable costs: $4.50 per unit
- Fixed costs: $28,000
- Tax rate 21%
Our first step would be calculating the sales figure. Davis Inc. earned $223,200 in sales. The total variable costs add up to $83,700 ($4.50 x 18,600 units). After subtracting the variable and fixed costs from sales, we will get the income before tax figure, which would be $111,500. Despite the fact that Davis Inc. already paid its fixed and variable costs, there is one more expense that it needs to account for before the owner(s) find out the net income after tax or the money they could potentially “take home”.
To find the taxes this company owes to the government, we simply need to multiply the income value we got before the tax payment by the tax rate. So, it turns out that Davis Inc. owes $23,415 in taxes. The after-tax income is now quite simple to calculate. Simply deduct $23,415 from $111,500 to get $88,085 of after-tax income.
This is how much money the company ended up with and how much it can distribute to its shareholders, reinvest back into the company, etc. We cannot tell much about this figure because it would be necessary to compare all the figures to the previous periods, competitors, and other businesses in the same industry. Nonetheless, a positive figure is already a good thing.
Author: Charles Lutwidge