Definition
Effective tax rate is the actual tax expense divided by pre-tax income, reflecting credits and timing differences.
Formula
Effective tax rate = income tax expense / pre-tax income
Example
Tax expense $210k on $1M pre-tax income equals 21%.
How to use it
- Use effective rate for forecasting when statutory rates are not reflective.
- Explain major shifts with credits, NOL usage, or jurisdiction mix.
Common mistakes
- Assuming the effective rate stays constant across income levels.
- Ignoring one-time items that distort the period rate.
Why this matters
This term matters because cash timing and risk are usually the difference between a plan that works on paper and a plan that survives. Use consistent definitions so decisions are comparable over time.
Practical checklist
- Write a 1-line definition for "Effective Tax Rate" that your team will use consistently.
- Keep the time window consistent (weekly/monthly/quarterly) when comparing trends.
- Segment results (channel/plan/cohort) before drawing big conclusions from blended averages.
- Sanity-check with a related calculator from the same category on MetricKit.
- Document common pitfalls so the metric doesn't get gamed.
Where to use this on MetricKit
Calculators
- IRR Calculator: Estimate internal rate of return (IRR) for an investment using yearly cash flows.
- Discounted Payback Period Calculator: Estimate discounted payback period using a discount rate (and compare to simple payback).
- Cash Runway Calculator: Estimate runway from cash balance, revenue, gross margin, and operating expenses (optionally with revenue growth).
- Break-even Pricing Calculator: Compute contribution margin, break-even units, and profit at a given volume based on price and variable costs.
- DCF Valuation Calculator: Estimate enterprise value using a simple DCF: forecast cash flows, apply a discount rate (often WACC), and add a terminal value.
Guides
- DCF valuation: forecast cash flows, discount rate, and terminal value: A practical guide to DCF valuation and WACC discount rate choices: how to forecast FCF, choose a discount rate, and avoid terminal value traps.
- Investment decision metrics: NPV vs IRR vs payback vs PI: A practical guide to investment decision metrics: when to use NPV, when IRR misleads, and how payback and profitability index fit in.
- WACC explained: how to estimate a discount rate for DCF: A practical guide to WACC: what it is, how to compute it, and how to use it (carefully) as a DCF discount rate.
- Discount rate: how to choose it for NPV and DCF: A practical guide to discount rates: what they mean, how to choose a rate (WACC vs MARR), and how to avoid common mistakes.
- Enterprise value vs equity value: how to bridge EV to equity: A practical guide to converting enterprise value (EV) into equity value using net debt and other claims (and avoiding common valuation mix-ups).