written by khatabook | November 22, 2022

Net Operating Profit After Tax (NOPAT) Definition and Formula

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NOPAT, the net operating profit after tax calculator, is used to compute a company's profit from operations after deducting tax. That shows the company’s net operating profit from its core business operations. It is the difference between revenues from operations and expenses directly attributable to such core business activities. 

NOPAT can be used as a comparison tool for two or more companies in the same industry that are leveraged differently. If the company raises funds through debt, the cost of that debt or the interest paid on the debts is excluded from the net operating profit after tax calculation. Essentially, net operating profit after tax is a company's net income when it is unleveraged.

Did you know? As of February 2022, Reliance had the highest net profit, with 31,900 crores

Understanding Net Operating Profit after Tax

Net Operating Profit after Tax (NOPAT) is a profitability measure that calculates a company's profit minus the leverage effect. It assumes that the company has no debt in its capital and, as a result, neglects the interest payments and tax benefits that companies receive by issuing debt in their capital. It is the cash earnings of a company if its market capitalisation were unleveraged, that is if it had no obligation. 

One-time losses or charges are not included because they do not accurately reflect a business’s financial revenue and profits. Some of these charges may be related to a merger or acquisition, which, if taken into account, may not provide an accurate depiction of the company's operations, even if they impact the company's bottom line that year. 

Analysts consider a variety of performance metrics when evaluating a company as an investment. The most commonly used performance indicators are sales and net income growth. Although sales are a key performance indicator, they speak about something other than operational efficiency. Net income includes both operational and debt-related tax savings. Net operating profit after tax is a hybrid calculation that lets analysts assess company performance without accounting for leverage. As a result, it is a more precise indicator of pure operational efficiency.

Also Read: Costing: Definition, Objectives, and Advantages

Importance of NOPAT

NOPAT is one of the most valuable methods for comparing operating income between companies in the same industry. Simple comparisons are solely concerned with a company's sales, which ignores the critical role that debt and leverage play in a company's financial structure. A high NOPAT indicates that a company's management is making critical decisions to ensure profitability. A low NOPAT, on the other hand, can expose growth constraints in a company. NOPAT allows you to compare businesses on an equal footing. As a result, it is regarded as one of the most effective tools for calculating the economic value added by a company.

Formula for Calculating NOPAT

EBIT, or earnings before interest and taxes, is a measure of how profitable a business is. Revenue less expenses, without taxes and interest, is EBIT. Operating profit and profit before interest and taxes are other names for EBIT.

EBIT gauges a business's profit level prior to tax and interest deductions. NOPAT, on the other hand, displays your company's profitability without taking non-operating costs like debt and lawsuits.

NOPAT Formula 1

EBIT (earnings before interest and taxes) is a measure of a company's profitability. EBIT is computed as revenue less expenses minus tax and interest. Other terms for EBIT are operating earnings, operating profit, and profit before interest and taxes.

EBIT is also known as operating income because it excludes interest and taxes from its calculations.

The net operating profit after tax formula is represented as follows:

NOPAT = Operating Income × (1−Tax Rate) 

This NOPAT formula is applied when you know your operating income and tax rate. A company's operating income is calculated by subtracting its gross profit from its operating expenses, and the tax rate is the percentage of tax paid by the company.

simpler NOPAT formula, NOPAT = Operating income × (1 - tax rate), NOPAT equals ₹200,000 X (1 - 0.4), or ₹120,000. As a result, NOPAT is ₹120,000.

NOPAT Formula 2 

The second NOPAT formula is used by businesses when the operating income is unknown. This formula is used when the company earnings before tax deductions and interest expenses are unknown.

NOPAT = (Net income + Non-operating income loss − Non-operating income/gain + interest expense + tax) × (1 − tax rate)

If EBIT is ₹10,000 and the tax rate is 30%, the net operating profit after tax is 0.7, or ₹7,000 (calculation: ₹10,000 x (1 - 0.3)). This is a rough estimate of after-tax cash flows without the tax benefit of debt. It should be noted that if a corporation has no debt, net operating profit after tax equals net income after tax. Analysts like to compare net operating profit after tax to similar companies in the same industry because some industries have higher or lower costs than others.

Also Read: Top Accounting Related Interview Questions with Answers

The Terms used to calculate NOPAT-

  • Non-operating income loss  - Non-operating expenses are offset by non-operating income in a company's accounting system. The business experiences a non-operating loss when expenses in this area outweigh income. Financial investments may result in non-operating losses for some companies.
  •  Non-operating income/gain- Gains arising from sources unrelated to the regular operations of the company or organisation are referred to as non-operating income in accounting and finance. Gains or losses from investments, asset sales, currency exchange, and other unusual gains and losses can all be classified as non-operating income.

Operating Income 

Operating income, also known as operating profit or Earnings Before Interest and Taxes (EBIT), is the revenue remaining after deducting operational direct and indirect costs from sales revenue.

Operating expense: 

An ongoing cost for maintaining a system, a business, or a product is an operating expense. The cost of developing or providing non-consumable parts for the product or system is its counterpart, a capital expenditure. It is the cost that the company incurs to generate 'Revenue.'

Operating profit: 

In both business and accounting, net income is an entity's revenue, fewer costs, depreciation and amortisation, interest, and taxes for a given accounting period.

To summarise the revenue calculations in plain English: Unit cost multiplied by the quantity sold equals total revenue. Net revenue is calculated as total revenue minus expenses and returns or (unit cost - the cost of goods sold) x the number of units sold.

The funds are left over after paying for the company's operating expenses.

Also Read: What is an Accounting Transaction? Example & Types of Accounting Transaction

Interest and Tax

Interest: The interest payment on any borrowed funds (similar to the interest individuals pay for a house loan or education loan etc.)

Tax: The amount of tax paid by the company (similar to the income tax paid by individuals)

Net Profit

The amount of money left over after deducting all costs and expenses. 

Operating profit and net profit are two critical metrics for any business. Operating profit informs us about a company's operational efficiency, whereas net profit is a measure of a company's overall profitability. Both of these parameters, however, have limitations. Operating profit excludes the impact of taxes on profitability, whereas net profit includes the effects of interest payments. 

First, compute your net income to calculate NOPAT using this NOPAT formula. Net income is calculated by deducting operating expenses from total revenue. Second, add the non-operating income loss, which includes, among other things, losses from selling substandard products at a lower price. The non-operating income gains must then be computed.

Non-operating income gain is the amount of money your company earns from non-operating activities such as investing. The interest expense is then added. This value is calculated by subtracting profit before tax from net profit. A tax expenditure is calculated by multiplying profit before tax by the applicable tax rate.

Advantages of Using NOPAT

It does not consider the effects of excessive leverage or debt financing. As a result, it provides a more accurate measure of profitability. It can compare two businesses in the same industry with different leverage levels.

It assists managers in understanding the business's operational efficiency and profitability. NOPAT is a popular business valuation method. NOPAT informs creditors and lenders about a company's ability to repay debt. It is a better analytical measure for lenders because it is a measure of profitability that shows profits from the business's core operations. NOPAT is a great predictor of a company's operational efficiency. Managers and executives can use this metric to make crucial operational efficiency decisions. 

Also Read: What are the Responsibilities of Debtors?

Disadvantages of NOPAT

The NOPAT formula compares businesses in the same industry but needs to account for the various stages of growth that those businesses may be in. The multiple stages of growth can have an impact on the business and its operations. Because NOPAT needs to take it into account in its calculations, NOPAT is only partially accurate for comparison purposes, even if the companies being compared are in the same industry.

In some cases, treasury staff may have done something that affected a company's capital structure. Because NOPAT needs to consider this, a business's potential must be fully realised. This is especially true for businesses that have made changes that will ultimately lead to better cash flow and are different from those used by a competitor. 

Conclusion

NOPAT assesses the efficiency with which a company conducts its core business operations. If the company has no debt, the net operating profit after tax is the profit that can be used to distribute dividends to shareholders. It can be used to compare one company's debt to another in the same industry with a different level of debt. As a result, the impact of interest and debt levels on firm operating efficiency is negligible. 

NOPAT calculations are generally performed theoretically or through questionnaires for financial modelling and other purposes. This is to compare the operating efficiencies of firms across industries without taking capital into account. The goal is to compare the operational efficiencies of firms across the industry regardless of capital mix/capital structure. Businesses of the same size can experience very different tax effects from having different debt levels. Because of this, comparing operational efficiency becomes difficult, and NOPAT is computed to take the capital structure mix effect into account.

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FAQs

Q: What is Operating Income?

Ans:

A company's operating profit includes revenue from operations only after deducting operating expenses directly related to the operations. All income and expense-related financing and investing activities are excluded.

Q: Does NOPAT include Depreciation?

Ans:

Yes, non-cash expenses like as depreciation and amortisation are included in NOPAT.

Q: How is PAT determined?

Ans:

Profit after tax (PAT) is the sum of money left over after deducting total business expenses from total revenue. It is a calculation that considers almost every financial transaction in your company, and total income equals revenue/sales plus other sources of income.

Q: Is it possible to have a negative operating income?

Ans:

Negative operating income is an operating loss, which means that the cost of goods sold and operating expenses together or separately exceed sales.

Q: Is NOPAT calculated using tax savings from existing debt?

Ans:

The efficiency of a leveraged company's operations is measured by its net operating profit after tax (NOPAT). NOPAT does not include tax savings from existing debt or one-time losses or charges.

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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.