What Is Net Operating Profit After Tax?
Net operating profit after tax (NOPAT) is a financial measure that shows how well a company performed through its core operations, net of taxes. NOPAT is frequently used in economic value added (EVA) calculations and is a more accurate look at operating efficiency for leveraged companies. NOPAT does not include the tax savings many companies get because of existing debt.
Net Operating Profit After Tax (NOPAT)
- Net operating profit after tax (NOPAT) measures the efficiency of a leveraged company's operations.
- NOPAT excludes tax savings from existing debt and one-time losses or charges.
- Mergers and acquisitions analysts use NOPAT to calculate the free cash flow to firm (FCCF) and economic free cash flow to firm.
Understanding Net Operating Profit After Tax (NOPAT)
Net operating profit after tax (NOPAT) is a company's potential cash earnings if its capitalization were unleveraged — that is, if it had no debt. The figure doesn't include one-time losses or charges; these don't provide a true representation of a company's true profitability. Some of these charges may include charges relating to a merger or acquisition, which, if considered, don't necessarily show an accurate picture of the company's operations even though they may affect the company's bottom line that year.
Analysts look at many different measures of performance when assessing a company as an investment. The most commonly used measures of performance are sales and net income growth. Sales provide a top-line measure of performance, but they do not speak to operating efficiency. Net income includes operating expenses but also includes tax savings from debt. Net operating profit after tax is a hybrid calculation that allows analysts to compare company performance without the influence of leverage. In this way, it is a more accurate measure of pure operating efficiency.
To calculate NOPAT, the operating income, also known as the operating profit, must be determined. Operating income is also referred to as earnings before interest and taxes (EBIT). It includes gross profits less operating expenses, which is comprised of selling, general, and administrative (e.g., office supplies) expenses. The NOPAT formula is
For example, if EBIT is $10,000 and the tax rate is 30%, the net operating profit after tax is 0.7, which equals $7,000 (calculation: $10,000 x (1 - 0.3)). This is an approximation of after-tax cash flows without the tax advantage of debt. Note that if a company does not have debt, net operating profit after tax is the same as net income after tax. When calculating net operating profit after tax, analysts like to compare against similar companies in the same industry, because some industries have higher or lower costs than others.
In addition to providing analysts with a measure of core operating efficiency without the influence of debt, mergers, and acquisitions analysts use net operating profit after tax. They use this to calculate free cash flow to firm (FCFF), which equals net operating profit after tax, minus changes in working capital. They also use it in the calculation of economic free cash flow to firm (FCFF), which equals net operating profit after tax minus capital. Both are primarily used by analysts looking for acquisition targets since the acquirer's financing will replace the current financing arrangement. Another way to calculate net operating profit after tax is net income plus net after-tax interest expense (or net income plus net interest expense) multiplied by 1, minus the tax rate.