Financial statements are one of the three financial statements used by companies to present their performance over an accounting period. These statements (along with the balance sheet and cash flow statement) are a key reading for investors to understand the companies they are investing in.
Benefit of Income Before Tax
Income before tax can be a particularly useful measure, especially if you study it over several years by comparing it with other metrics.
Income before tax is calculated by subtracting the company’s operating expenses from total revenues. For example, if a company has $10 million in revenues and $8 million in operating expenses, it has $2 million in income before tax.
Considering income before tax is beneficial because tax laws tend to change from time to time based on economic, social, and political factors. This causes fluctuations in after-tax income in a way that does not always indicate the economic driver that operates under the company’s hood.
Income before tax should be more stable than after-tax income. Therefore, you should look at the long-term income before tax number for the company and compare it to total sales, tangible assets, or shareholders’ equity. Place it side by side with other companies in the same sector or industry to fully understand its performance. Some industries tend to outperform others through this metric, so making an appropriate comparison is important for this type of analysis.
Considering income before tax also helps in comparing companies, as everyone has the same federal tax rate, but state taxes vary significantly.
Profit Margin Before Tax
The profit margin before tax is considered when comparing income before tax to total sales. This metric tells you how many cents the company earned in profit for every dollar in sales. You can find the profit margin before tax by dividing income before tax by total sales and multiplying it by one hundred.
For example, if a company has $1 million in total sales and has an income before tax of $200,000, the company has a profit margin before tax of 20%. This means that for every dollar of products sold, the company made 20 cents.
Income Tax Expense in the Income Statement
Income tax expense is the total amount that the company paid in taxes. This amount is often broken down by source (federal, state, local, etc.) in the income statement, annual report, or in the filing of Form 10-K.
You should be aware of the tax laws affecting specific companies and/or business transactions. For example, assume that the company you were analyzing purchased $100 million in preferred stock with a 9% dividend yield at the time of acquisition.
You could rightly assume that the company would receive $9 million annually as dividends on that preferred stock. If the company has a tax rate of 35%, you might assume that $3.15 million of those dividends would be paid to the U.S. government. In reality, companies receive a 70% exemption on the dividends they receive from preferred stock, a benefit not enjoyed by individual investors. Because of this benefit, only $2.7 million of the $9 million in dividends would be subject to tax.
Corporate tax rates in the United States vary significantly over time. In the past, they were often progressive taxes (tax brackets in which tax rates increase over time as a company’s taxable income rises), but as of 2020, the corporate tax rate is a flat 21% on all profits of one dollar or more. Remember that some companies face the risk of triggering additional special taxes, such as those imposed on regulated investment companies in the form of classic C corporations.
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The deduction of income taxes from pre-tax company income will leave you with net income. This figure is used more frequently to compare profitability between companies, but considering income before taxes is also useful and, in some ways, a better measure of financial health.
Source: https://www.thebalancemoney.com/income-before-tax-and-income-taxes-357579
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