What is Net Operating Profit After Tax?
Net Operating Profit After Tax (NOPAT) is a term that shows a company’s income from operations without considering interests. Since the interest payments for different companies depend on their capital structure, comparisons between them can be challenging. However, NOPAT removes the effects of interest payments from a company’s operations to allow better comparability.
NOPAT is a financial metric that investors can use to evaluate a company’s operations. Without the impact of interest, investors can determine how the company has performed due to its core operations. Since the capital structure of companies may differ, NOPAT can provide a better indicator of operational efficiency.
How to calculate Net Operating Profit After Tax?
As mentioned, net operating profit after tax shows a company’s earnings by excluding any interest expenses from it. However, the calculation of NOPAT isn’t as straightforward as adding interest expenses back to a company’s net income. It is because there may be some tax implications associated with interest payments as well.
Investors can use one of the two formulas below to calculate a target company’s net operating profit after tax.
Net Operating Profit After Tax = Operating Income (or Income from Operations) x (1 – Tax Rate)
The above formula calculates the net operating profit after tax by not including interest while also accounting for taxes. It uses operating income that is generally available in a company’s income statement. Similarly, investors can use the formula below, which may need more information for NOPAT calculation.
Net Operating Profit After Tax = (Net Income + Interest Income + Tax + Non-Operating Gains or Losses) x (1 – Tax Rate)
The above formula also provides the same net operating profit after tax. However, it adds the company’s tax and interest expenses back to its net income. It also adds any non-operating gains or losses to the net income. Lastly, it removes the effect of taxation from the residual amount to reach the NOPAT. The information necessary to calculate the NOPAT using the above formula is also available in the income statement.
Example
A company, Red Co., reported a net income of $200,000 during the last financial period. It also showed an interest expense of $30,000, tax expense of $25,000, and non-operating losses of $20,000. Red Co. pays a corporation tax of 20%. Therefore, its net operating profit after tax will be as follows.
Net Operating Profit After Tax = (Net Income + Interest Income + Tax + Non-Operating Gains or Losses) x (1 – Tax Rate)
Net Operating Profit After Tax = ($200,000 + $30,000 + $25,000 + $20,000) x (1 – 20%)
Net Operating Profit After Tax = $125,000 x 80%
Net Operating Profit After Tax = $100,000
What is the importance of Net Operating Profit After Tax?
Net operating profit after tax is useful in various calculations. It can help investors in calculating economic value added (EVA) or unleveled free cash flow. It also allows investors to compare companies with different capital structures. Some experts consider NOPAT to be a better measure of a company’s performance than its net income. NOPAT is also useful in acquisitions and mergers as a company’s capital structure is likely to change significantly after them.
Conclusion
Net operating profit after tax considers a company’s income after taking out the effects of interest payments. It is useful for comparisons between companies of varying capital structures. Investors can calculate a company’s NOPAT using the information provided in its income statement.
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