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written by | March 9, 2022

How to Calculate Profit After Tax and its various implications

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The collection of taxes is the government's primary source of revenue in India. Firms, individuals, domestic companies, foreign companies, and so on all have different tax rates. In India, there are a variety of taxes that are split into two categories: direct taxes and indirect taxes. Wealth tax, corporate tax, and income tax are examples of direct taxes, whereas excise duty, customs duty, goods and services tax, and other indirect taxes are examples of indirect taxes. Businesses need to track their profits to assess their success and possibilities for expansion. Certain elements, like taxes, debts, and expenses, may, however, impact their profitability. Net profit after Tax is an easy-to-understand financial measurement for evaluating an organization's profitability over a certain period.

We define net profit after Tax, detail the processes for computing net profit after Tax, present an example calculation, and discuss various applications for this financial measurement in this article.

What are Profits?

A profit is a financial gain derived from all commercial activity for any company. It is the excess of returns over all of the company's or business's net expenses. Every business attempts to increase profits by lowering expenses or raising selling prices. Profits made by a firm are frequently re-invested in the company or distributed as dividends to its shareholders.

Profit margins are divided into four categories:

  • Gross Profit
  • Operating Profit
  • Pre-Tax Profit
  • Net Profit or Profit after Tax

Did you know? The Net income after taxes or the profit after taxes is one of the most analysed figures in the financial statements of a company.

What is net profit after Tax?

Net profit after Tax (NPAT) is a financial indicator that shows how profitable a company's primary business is. It does not include any tax benefits that a business may obtain as a result of its current debt, as well as one-time losses or charges, such as acquisition-related expenses. Because one-time charges do not accurately reflect an organization's underlying profitability, net profit after Tax removes them. Organizations frequently use net profit after Tax with economic value added (EVA). As a hybrid computation, it may provide information into the company's performance and operational efficiency without the influence of leverage.

Similarly, analysts may utilize net profit after Tax to perform additional cash flow estimates. This may aid in determining the organization's development and cash flow potential in the absence of debt.

The formula for Profit after Tax

PAT's formula can be summarised as follows:

Profit After Tax (PAT) = Profit Before Tax (PBT) – Tax Rate

Profit before Tax:

It is calculated by subtracting total expenses (including operational and non-operating) from total revenue (operating revenue and non-operating revenue).

Also read: 3 Golden Rules of Accounting, Explained with Best Examples

Taxation:

Taxation is based on PBT, and the rate of taxation is determined by the country's geographical position. In India, for example, the taxation slab varies across corporate enterprises, individual ownership firms, and salaried personnel.

Profit after-tax, often known as net profit, is calculated by subtracting the taxable amount from PBT. The taxable component is not necessary in the case of a negative profit before Tax (where total expenses exceed total revenue). Tax is only applicable in the case of profitability.

The net income must be reduced by expenses and costs. The following are some of the deductions:

  • Cost of goods sold
  • Depreciation
  • Overhead and general expenses
  • Interest expense on any debt, including short-term debt and the interest portion of long-term debt, such as bonds issued, is subtracted from net operating earnings.
  • Taxes are remitted to the government on a regular basis.
  • Costs associated with the company's product research & development.
  • Charge-offs -  these are expenses that can be written off at one-time or as losses.

The profit after taxes for a wholesale company with ₹ 1,00,000 in revenue are shown in the income statement below -

ABC Ltd.

Profit and Loss Statement

Revenue

 

1,00,000

Less: Direct Costs

 

 

COGS

 

(35,000)

Gross Profit

 

65,000

Less: Indirect Costs

 

 

Operating Expenses:

 

 

Selling

15,000

 

General

5,000

 

Administration

5,000

(25,000)

Operating Profit/ EBIT

 

40,000

Less: Interest

 

(10,000)

Earnings before Tax (EBT)

 

30,000

Less: Tax

 

(10,000)

Net Profit/ PAT

 

20,000

Also read: All About Tax Deducted At Source

PAT Margin (%)

Net profit after taxes is divided by total sales to calculate profit margin. This is an important basic measure since it informs investors how much money the company makes every rupee of revenue. The management's efficiency in generating profit from sales after meeting operating and overhead expenditures is measured by the net profit margin.

It is assumed that a firm's PAT growth margin is improving on a quarterly or annual basis, indicating that the company is doing well.

Advantages

  • PAT aids in determining the health of a company. It is a significant criterion for shareholders to evaluate business performance.
  • PAT calculates the profit margin, operating efficiency, and remaining profits, as well as dividends, which are paid after all expenses have been paid.
  • A higher PAT indicates a business's higher efficiency, whereas a lower PAT shows a business's ordinary or below-average operational efficiency.
  • Dividends are distributed in direct proportion to PAT. The dividend yield would be higher if the amount was bigger.
  • The stock price of a company is likewise influenced by PAT, as profit growth aids stock price appreciation and vice versa.
  • The government of the particular company receives the taxable money as a result of its profitability that is used for the development and progress of the separate countries. Payment of dividends to shareholders is the company's way of sharing their profits and thanking the shareholders for their trust in the company and their support. 

All of the preceding conditions are met in the case of profitability, or when income is higher and expenses are lower.

Disadvantages

  • If the tax rate is raised, the company's net profit after Tax, or bottom line, falls, leaving less money for the shareholders as well as "reserves and surpluses."
  • Losses result from inefficient operations. As a result, the management, business model, and cost-effectiveness of the company are all in question.
  • Only in the case of profitability is it calculated. Tax is not applicable during losses, hence the firm is not viable during continual losses.

Also read: Know About Paying Taxation of Income Earned From Selling Shares

Significance of PAT in share market

When a corporation is publicly traded, the profit after tax margin (PAT) is used to indicate how any change in the value can manipulate the stock prices. Profit after Tax is determined on a per-share basis if the company is publicly traded, and it appears on the income statement.

Importance of PAT in accounting

Profit after Tax is a crucial metric that is used in ratio analysis to determine a company's profitability. PAT is determined on a share basis in the case of a publicly-traded firm, and this information is used to evaluate the value of the company's stock. A high PAT number indicates strong efficacy and can entice more investors to acquire stock.

Profit after Tax is a financial ratio used by both investors and creditors to determine whether a company's activities are profitable or not. Even though it is not an accurate measurement, it is frequently used as a gauge.

The PAT analysis can also be used to determine a company's operational efficiency without having to look at its financial structure.

Calculating the Profit after Tax is critical for understanding the actual amount that a firm makes in a given working year. The profit after tax index also aids the company in determining whether it needs to cut costs.

Companies' profit after taxes is obtained and examined to create reports that allow for healthy comparison and analysis amongst companies. A high PAT shows that the company is profitable. A large profit margin translates to higher dividends for equity shareholders. If the Profit after Tax statistic is negative, the company is losing money. As a result, the money cannot be taxed.

What are the factors that affect Profit after Tax?

Numerous factors influence a company's profits and profitability. These variables can be qualitative or quantitative.

The quantitative factors are often identified easily and changed as per needs. These include - 

  • Sales revenue
  • Production / Manufacturing costs
  • Inventory numbers
  • Taxation.  

The amount of profitability of a corporation is heavily influenced by sales revenue. Another crucial component in a company's capacity to sustain a high level of profitability is cost management. Inventory values are also important. Depreciated inventory can result in a reduction in profit margins, which can be detrimental to the organization. Increased inventory sales will result in larger profit margins.

Taxation is an external component that influences the profit after tax level. To obtain cash for specific government expenditures, governments levy forced taxes on persons or organizations. Taxation continues to have a significant impact on net income.

Various qualitative aspects influence Profit after Tax. These factors include the sale of a product, market share value, successful advertising, changes in client preferences, firm leadership, employee training programs, sales incentive programs, seasonal variations, advertising level and effectiveness, and market competition strength.

Also read: What is the List of Accounting Standard

Conclusion:

Profit after Tax is the revenue that a company avails of after meeting all its expenses. Higher profitability equals higher PAT, while lower profitability equals lower PAT. However, unusual decreases or increases in profitability, or even losses, might occur as a result of exceptional item losses or profits.

A tax rebate may be adjusted, and a refund added to the loss amount in some situations, resulting in a reduction in losses. PAT is the most important feature of any corporation because it defines the future of the company. After all, the remaining profits are used to fund capital expenditures. 

Do you struggle with GST and payment management? Install the Khatabook app, a one-stop shop for all income tax and GST filing, employee management, and other difficulties. Now is the time to give it a shot!

FAQs

Q: What is profit after tax?

Ans:

Profit after Tax is the amount that remains after a firm has paid off all of its operating and non-operating expenses, other liabilities, and taxes. This profit is what the corporation distributes to its shareholders as dividends or keeps as retained earnings in reserves.

Q: Why does a company's EPS drop while its PAT increases?

Ans:

Profit after tax, net profit, or profit available to equity shareholders is referred to as PAT. Due to a rise in the number of shares issued by the corporation, a company with increased profits/PAT may have a lower EPS than previous results. A rise in the number of shares may be due to the issuance of bonus shares, the splitting of shares, the exercising of stock options, or the issuance of new equity shares.

Earnings per share, or EPS, is a key indicator that investors, shareholders, and analysts monitor. PAT is divided by the number of shares to arrive at this figure. Because the denominator represents the number of outstanding shares, any decrease in that number, even a slight increase in the numerator, can have an inverse effect on the EPS.

Example:

In the first year, a firm with a PAT of ₹ 100 crore has 10 crore outstanding equity shares. In this situation, the EPS would be 10.

In year 2, the PAT rises to ₹ 120 crores and the company issues a bonus issue in the ratio of 1:1, bringing the total number of shares outstanding to 20 crores. The EPS in this situation is 6.

As a result, we can see that an increase in the number of shares has an impact on the EPS, even though the company's PAT levels have increased.

Q: What does a company's profit after tax reveal?

Ans:

Every company's PAT margins must be calculated.

PAT are the line items of interest for a company's shareholders, therefore knowing what they signify and how to use them is a must when evaluating the stock's attractiveness to equity investors.

Q: What are the expenses to be deducted from net income to arrive at a profit after tax?

Ans:

  • Cost of goods sold
  • Depreciation value of the asset
  • Amount has written off
  • Interest expense
  • Overhead costs
  • Selling, distribution, general and administrative expenses. 
  • Research and development costs

Q: What does PAT growth entail?

Ans:

Analysts compare this year's PAT to last year's PAT, this quarter to last quarter, or this quarter to the similar quarter the previous year. Divide the difference by the previous period's PAT, then multiply by 100. This calculates the percentage growth rate between the two time periods.

As an illustration, consider the following scenario.

Assume your company earned ₹ 4,00,000 in net profit last year and ₹ 4,80,000 this year. There is an ₹ 80,000 differential in the two years.

You get 0.2 if you divide this by last year's PAT, which was ₹ 4,00,000.

When you multiply this number by 100, you get a net income increase of 20% over the previous year.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.