Net operating profit after tax is also called by its acronym of NOPAT. This refers to the potential earnings (in cash) of a corporation working under the pretense that it has no debt. This NOPAT metric is often utilized in so-called EVA economic valued added calculations. The formula for determining NOPAT is as follows: the operating income times the result of one minus the tax rate. For companies which are debt leveraged, this NOPAT proves to be a more precise and exact way of examining their operating efficiencies. As such it does not factor in the tax advantages which a number of corporations enjoy from their debt load.
Analysts and accountants consider a number of varying performance metrics when they are evaluating a corporation in which to invest. The two most frequent performance measures turn out to be sales (or revenue) and net income growth. With the revenue/sales figures, this delivers a top line performance metric. It does not say anything about the company’s operating efficiency value though. Similarly the net income does include the operating expenses of a firm, yet it also factors in the net tax benefits and savings from the company’s particular debt leverage.
This is where the Net operating profit after tax comes in as a useful hybrid form of alternative calculation. It permits the analysts to compare and contrast a company’s performance against past metrics and other companies by removing the effects of debt leverage from the equation. This allows analysts to truly fairly measure one company against another, regardless of the two firms’ net debt positions.
It always helps to consider a real world, concrete example with these complex terms. If a company’s EBIT Earnings Before Interest and Taxes was $12,000 and their tax rate was 25 percent, then the calculation for NOPAT would translate to $12,000 times the result of one minus .25,( or .75). This equals $9,000 as a NOPAT. It is an after tax cash flow estimate that does not include the tax benefits of debt. For those companies without debt, Net operating profit after tax equals the same amount as does the net income after tax.
It is worth noting that analysts prefer to compare and contrast firms within the same industry when utilizing the NOPAT metric. This is because every industry has its own normal range of operating costs. Some industries’ typical expenses turn out to be dramatically lower or higher than others’ do.
For example, cable utilities would have extremely high operating costs associated with initially putting in, continuously upgrading, and maintaining their technology and physical hard-wired distribution networks. Soft drink businesses like Dr. Pepper/Snapple Group (DPS) have relatively low costs since they generally license out their products to other companies which produce and distribute them on their behalf.
Net operating profit after tax has other uses besides the helpful view of a company without its debt leverage being considered. Those analysts who follow and predict mergers and acquisitions utilize this NOPAT value all the time. It helps them to figure up the FCFF free cash flow to firm. This is equal to the NOPAT less any changes to working capital. It also equates to the net operating profit of the firm after taxes less the firm’s capital.
These two metrics NOPAT and FCFF are commonly utilized by those types of analysts who hunt down targets for acquisition. The reason for this is that the financing of the acquiring firm will then substitute in for the present financing arrangement (their corporate debt).