# Net Operating Profit After Tax (NOPAT)

## Did you know?

Net operating profit after tax (NOPAT) is a profit measurement that indicates how much profit a company generates by looking at its operating income minus taxes. When calculating NOPAT, we disregard any debt the company has, meaning we treat all of the company’s revenues as if they come from equity/shareholders’ equity. This is caused by the fact that some companies use debt to avoid additional taxes.

NOPAT provides a more accurate look if we want to estimate how efficient a company is in using its assets to generate income. To put it into perspective, net income—calculated by eliminating all expenses from total profit—sometimes gives out an inaccurate outlook since it also takes the company’s debts into account.

NOPAT is proven to be a solid tool if we want to compare two or more companies by not including debts from their capital structure.

## Net Operating Profit After Tax Formula

$NOPAT = \text{Operating Profit} \times ( 1 - \text{Tax Rate})$

For this equation, you can find operating income by subtracting almost all expenses, except tax and interest from total revenue. These expenses include the cost of goods sold, salaries, benefits, rents, overhead, and depreciation. The difference between net income and operating income is that net income also subtracts tax and interest from total revenue. Operating income can also be referred to as earnings before interest and taxes (EBIT).

Tax rate, on the other hand, is the percentage you are taxed from your income. Corporations are usually taxed based on their earnings while individuals are taxed on their personal income.

Often, companies use debt to reduce tax expenses. This is because it’s ‘cheaper’ to finance their operation using debt instead of equity. For instance, let’s say a fully financed company with shareholders’ equity has a pre-tax income of $100,000. If the government charged 30% of the firms’ income as tax, the income will be deducted. This leaves$70,000 as the leftover, which is then distributed to investors as dividends.

On the contrary, if investors finance the company fully as debt instead of equity, the company may be then exempt from taxes if the amount of profit before taxes is the same as the amount of interest that should be paid to investors, making the net profit of the company equals to 0. The interest will then be divided up proportionally to investors. As a side note, investors still need to pay the tax from receiving the company’s money as either interest or dividends.

## Net Operating Profit After Tax Example

Dahlia, an analyst, wants to measure how decent a particular company is to be a candidate for a merger as requested by one of her clients. To help with her calculation, she decides to use NOPAT instead of net income to decide how profitable the company is.

After looking at the company’s balance sheet, she found out that the company has operating earnings before interest and tax of $60,000. The corporation tax rate is 30% of profits. Can we calculate the company’s net operating profit after tax? Let’s break it down to identify the meaning and value of the different variables in this problem. • Operating Income = 60,000 • Tax Rate = 30% We can apply the values to our variables and calculate net operating profit after tax: $NOPAT = 60{,}000 \times ( 1 - 0.3) = \42{,}000$ In this case, the net operating profit after tax of the company would be$42,000.

From this result, we can see that the company would have a net profit of \$42,000 if we disregard the interest payment incurring from debts. This number provides a better understanding of how the company may perform in the future. Dahlia can choose to recommend this company or not based on the total assets of the company or other variables if needed.

## Net Operating Profit After Tax Analysis

NOPAT is a powerful tool to gauge how profitable a company is whether a company is highly leveraged or not. By disregarding the company’s debt, NOPAT gives a true portrayal of the company’s profitability. NOPAT also doesn’t include any sudden fee charges that may befall the company since it is an anomaly that may give an inaccurate prediction of the company’s future.

Taking advantage of debt’s tax benefit is not without controversy. That’s why, if we use net income to calculate the efficiency of a company in proportion to its assets, it may give the wrong impression. The net income may be smaller thanks to debt financing instead of bad performance. NOPAT dismisses the disadvantages of this particular possibility by ignoring the company’s leverage use.

Most analysts prefer to use NOPAT as a measure of a company’s growth. By using NOPAT, they can compare the performance of different companies within the same industry by paying no mind how leveraged each of these companies. If they base their calculations using net income instead, they may come out with wrong conclusions since one company may seem to have low profitability because of high leverage, even though it’s not true.

NOPAT is often used to estimate the free cash flow to firm (FCFF) of a company. You calculate this by subtracting changes in working capital from NOPAT. FCFF or other similar calculations are used by analysts to determine which acquisition targets meet the criteria of the acquirer. NOPAT, however, may not be ideal for measuring a company’s general performance since it neglects debt. For example, NOPAT doesn’t have much utility for internal calculations of the company, unlike net income.

## Net Operating Profit After Tax Conclusion

• The net operating profit after tax measures a company’s net profit, assuming the company has no debt.
• This formula requires two variables: operating income and tax rate.
• NOPAT provides a more accurate indication of a company’s profitability as it disregards all debts the company may have.
• Analysts often prefer NOPAT instead of net income when comparing the performance of multiple companies within the same industry.

## Net Operating Profit After Tax Calculator

You can use the net operating profit after tax calculator below to quickly calculate a company’s net profit assuming the company doesn’t have any debts by entering the required numbers.