Net operating profit after tax (NOPAT) definition
/What is Net Operating Profit After Tax?
NOPAT is an acronym that stands for Net Operating Profit After Tax. The measurement is a good way to understand the underlying profitability of a business by stripping away the effects of financing and tax effects related to financing, since its primary focus is on earnings generated by operations.
How to Calculate Net Operating Profit After Tax
The formula for net operating profit after tax is as follows:
Net operating profit after tax = Net operating income x (1 - tax rate)
The net operating income portion of that calculation is derived as follows:
Net Operating Income = Net income + Taxes + Interest expense + Non-operating gains or losses
If a company has no financing costs or interest income, then NOPAT is the same as net income. In this situation, a simple net income calculation should be sufficient for interpreting the results of an organization. Thus, NOPAT is not especially useful for a company that has little or no debt.
When to Use NOPAT
There are several situations in which the use of NOPAT can be particularly effective. Here are several examples:
Business comparisons within an industry. NOPAT is particularly effective when comparing the results of several companies in the same industry that employ different financial structures, since the results of the analysis will exclude the effects of financing. Otherwise, the results of a highly leveraged company would likely be seen to spike or drop in relation to the results of other companies with more conventional financial structures.
Internal performance reviews. A business might use NOPAT internally to evaluate the operations of its divisions without having any interest or tax line items clouding their performance numbers. This makes it easier to spot high-performing and low-performing divisions.
In free cash flow calculations. NOPAT is used in free cash flow calculations, where the calculation is:
NOPAT + Depreciation and amortization - Working capital changes - Capital expenditures = Free cash flow
When Not to Use NOPAT
NOPAT should not be used to compare companies in different industries, since the operations of these organizations will still have essentially different cost structures. For example, the NOPAT of a capital-intensive manufacturing organization may be quite different from the NOPAT of a services business.
Related AccountingTools Courses
The Interpretation of Financial Statements
Example of Net Operating Profit After Tax
For example, a business has revenues of $1,000,000, cost of goods sold of $650,000, administrative expenses of $250,000, and interest expense (on a heavy debt load) of $100,000. Its tax rate is 21%. The company's income statement reveals net income of $0, which seems to imply that the organization is not capable of generating a profit. However, when the interest expense is stripped away and the tax rate is applied to the remaining profit, it is apparent that the company has an after-tax operating profit of $79,000.