Figuring out your business's income before taxes is pretty simple. The net profit before tax starts with your income for the reporting period, whether that's a month, quarter or year. Then, subtract your business expenses, except taxes. This gives you your business's EBT, or earnings before tax.
The Net Income Definition
Gross income is defined as how much money you make in a reporting period. The net income definition is the amount of money you make after deducting expenses. Unless you run your business on a cash basis, income and expenses include money you owe, not just what you pay or get paid.
Say you've been paid $240,000 this month but you've completed jobs worth another $60,000. Your gross income for the month is $300,000. If you write $30,000 in checks to suppliers and have another $10,000 in bills you haven't paid yet, your expenses are $40,000. The net income formula says your net is $260,000.
Income Tax Expenses
Calculating income tax expenses is a lot simpler than calculating income before taxes. A skilled accountant knows many ways to reduce a business tax bill, sometimes all the way to nothing. A common practice when drawing up income statements is to use historical data.
Suppose, for instance, that your EBT is $675,000. Your tax expense should be roughly what it was the last time you had that much net income unless something significant, such as tax law, has changed. You report the anticipated tax bill as a line item on the income statement.
The Income Statement
The income statement calculates your net income for the reporting period based on the net income formula. There are two main approaches – single step and multiple step. The difference is how they treat gains and losses that aren't parts of your regular business, such as government fines or payment from winning a lawsuit.
Single or Multiple Steps?
For a single-step income statement, you add up all your income and gains, then add your expenses and losses together. Subtract the negative items from the positive and you get your net income. The last line above the entry for your tax expense gives you your income before taxes.
A multiple-step income statement is more complex:
- First, subtract the cost of goods sold from your sales revenue to get gross profit.
- Next, subtract operating expenses, such as office supplies and advertising and sales commissions, to get your operating income.
- The next section lists nonoperating income and expenses, such as investment profits, interest expenses and losses from lawsuits. Separating them out makes it easier to see how much revenue your operations, the core of your business, are doing.
- Add the operating and nonoperating income totals together to get your net income for the period.
By simply stopping your calculations before you include income tax expense, you get your net income before taxes.
EBT, EBIT, EBITDA
EBT is only one of the acronyms used in discussing net income:
- EBT: Earnings before taxes. This helps to compare the value of companies operating under different tax laws.
- EBIT: Earnings before interest and taxes. This can be another useful tool for comparing whether companies are equally profitable without looking at how they're financing.
- EBITDA: Earnings before interest, taxes, depreciation and amortization. This excludes most nonoperating expenses, allowing analysts to focus entirely on operating income and expenses. As depreciation can be a substantial expense, critics of EBITDA say it distorts the financial reality.
You can derive these from each other. One formula for EBIT, for example, is EBITDA minus depreciation and amortization. You can also derive them simply by adjusting the net income formula to leave out interest, depreciation and amortization.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com