What Is Pre-Depreciation Profit?

Pre-depreciation profit includes earnings that are calculated prior to non-cash expenses. Non-cash expenses appear as separate income statement expense line items, but no actual cash is spent on these items. Depreciation costs are generally allocated according to a certain rate or percentage, depending on the depreciation method used.

Key Takeaways

  • Pre-depreciation profit includes earnings that are calculated prior to non-cash expenses.
  • Non-cash expenses appear as separate income statement expense line items, but no actual cash is spent on these items.
  • Depreciation costs are generally allocated according to a certain rate or percentage, depending on the depreciation method used.

Understanding Pre-Depreciation Profit

Pre-depreciation profit is calculated because it provides a cleaner number that can help determine a company's ability to service debt. Much like free cash flow, pre-depreciation profit is a measure of a company’s actual cash flow. Non-expense items lower a company's reported earnings, so a pre-depreciation profit would show a higher profit in comparison to profits calculated after depreciation. Depreciable items include vehicles, real estate (except land), computers, and office equipment, machinery, and heavy equipment.

Pre-depreciation profit is calculated before non-cash expenses, notably before depreciation. Depreciation allocates the cost of tangible assets over its economic and useful life. Depreciation is done for accounting and tax purposes and is recognized during the period the asset is expected to be used, starting as soon as the asset goes into service.

However, the depreciation method may vary, as will the length of time the asset is depreciated. The various depreciation methods may include declining balance or straight-line methods. It’s used to recognize the declining value or wear and tear of an asset. The pre-depreciation profit still includes various other cash expenses, such as marketing-related expenses, salaries, and rents. The convenience of the pre-depreciation profit is that it’s relatively easy to calculate. Just using the income statement, investors and analysts can calculate the pre-depreciation profit as a quick cash flow measure.

Non-cash expenses are reported on the income statement but do not involve the exchange of actual cash. Depreciation is the most common non-cash expense, with these non-cash items impacting the income statement and taxable income.

Example of Pre-Depreciation Profit

For example, a company purchases a piece of equipment for $100,000. The company will depreciate the asset over 10 years, depreciating the asset at $10,000 a year. The company’s depreciation expense of $10,000, a non-cash expense, would show up each year on the income statement, reducing taxable income. This item would not show up on the cash flow statement.

Pre-Depreciation Profit vs. EBITDA

Unlike earnings before interest, taxes, depreciation, and amortization (EBITDA), pre-depreciation profit is a profitability measure that is before non-cash charges. EBITDA is a profitability measure, also known as operating profit, but it includes actual cash charges. EBITDA is the earnings before non-cash depreciation, but this measure also excludes the cash charges interest, and tax.

EBITDA is a measure of a company's overall financial performance that is sometimes used as an alternative to net income. However, the EBITDA number can be misleading because it strips out the cost of capital investments like property, plant, and equipment.