Income Before Tax on Statements
Investing Lesson 4 - Analyzing an Income Statement
By Joshua Kennon
With EBITDA out of the way, now it's time to turn our attention to one of the most important lines on the income statement, which is income before tax. What is income before tax? After deducting interest payments and, depending on the business, other expenses, you are left with the profit a company made before paying its income tax bill. This figure allows you to see what the business would have earned if it did not have to pay taxes to the government.
Over time, it can be a particularly useful metric, especially if you examine it not in isolation by looking at a single year but throughout the entire business cycle, when compared to either total sales, tangible assets, or shareholders' equity. This is because income tax laws change from time to time and political administration to political administration, which can cause after-tax income to fluctuate in a way that isn't always indicative of the power of the economic engine a business has going for it. Income before taxes, on the other hand, should be much more consistent. You'll want to look at a firm's long-term income before taxes figure relative to those three items and put it side by side with other companies in the same sector or industry. When you do, you'll quickly come to realize that some sectors and industries are inherently superior to others. To be perfectly blunt about it, it isn't an accident that the best stocks to own over long periods of time have historically been clustered in a handful of sectors and industries.
Unless there is a fundamental shift in the core economics of both a nation and the world, it's a lot harder to build wealth by owning a steel mill than it is a high quality packaged food company or a convenience store than it is a well-run bank.
Income Tax Expense on the Income Statement
The income tax expense is the total amount the company paid in taxes.
This figure is frequently broken out by source (Federal, state, local, etc.) either on the income statement or somewhere in the annual report or Form 10-K filing.
You should be fairly familiar with the tax laws affecting specific companies and / or business transactions. For instance, say the business you were analyzing purchased $100 million worth of preferred stock that, at the time of acquisition, boasted a dividend yield of 9% (we'll talk more about preferred stock later in this lesson as it pertains to the calculation of income on the income statement). You could rightly assume the company would receive $9 million a year in dividends on the preferred. If the company had a tax rate of, say, 35%, you may assume that $3.15 million of these dividends are going to be paid to the Uncle Sam. In truth, corporations get an exemption on 70% of the dividends they receive from preferred stock, something individual investors do not enjoy. Thus, only $2.7 million of the $9 million in dividends would be subject to taxation.