What Does Pretax Operating Income Mean?
Pretax operating income (PTOI) is an accounting term that refers to the difference between a company's operating revenues (from its primary businesses) and its direct expenses (except taxes) tied to those revenues. It is a measure of a company’s operating efficiency, and is calculated as:
PTOI = Gross Revenue – Operating Expenses – Depreciation
Understanding Pretax Operating Income (PTOI)
Pretax operating income (PTOI) is a company’s operating income generated from its business activities, before taxes are factored in. PTOI excludes nonoperating forms of revenue and nonrecurring transactions such as capital gains on assets and profits from unrelated investments in other companies (unless its main business is investment in other companies). For instance, it excludes legal expenses, investments, and rents received, which are forms of noncore business income.
It is one of the best barometers for the basic health of a business because it measures both the revenue and expenses associated with the company's primary business activities. While taxes must ultimately be subtracted from this amount, viewing the company's primary operations on a pretax basis gives its shareholders, analysts, and decision-makers a clearer picture into the aspects of profitability that the company can control. Also excluding taxes helps to effectively compare the financial health of similar companies, given that these companies may have different capital structures which elicit different tax rates, even if the companies have the same revenues.
It's also important to note that the PTOI helps eliminate a false sense of security or panic associated with certain infrequent occurrences like lawsuits, gains or losses on currency exchanges, or the appreciation of capital assets. As these are included in the final accounting of a company's profit or loss, they can create a false sense of security or peril. However, the PTOI is a non-GAAP measure, so what is included and excluded for its derivation differs by company and industry.
Another metric that excludes earnings that occur outside of a business's general operations is the Earnings Before Interest and Taxes (EBIT). The EBIT is essentially the pretax operating income a firm would earn if it had no debt. Its calculation excludes interest expenses, interest income, and nonoperating income/loss.
The pretax operating margin, a measure of operating profitability, is calculated by dividing the pretax operating income by revenues generated by a company. This margin allows investors to understand true business costs of running a company. To calculate the after-tax operating income (ATOI), multiply the EBIT by one minus the corporate income tax on operational income.