NOPAT Formula: Calculate Net Operating Profit After Tax

Understanding your business’s true operational performance can be challenging when debt and financing decisions cloud the picture. Net operating profit after tax (NOPAT) cuts through this complexity by showing you exactly how profitable your core business operations are, independent of how you’ve chosen to finance them.

NOPAT is a crucial financial metric that reveals your company’s operating profitability by removing the effects of debt financing (like interest payments) and non-operating income (such as gains or losses from investments). This gives you a clear picture of your business’s core performance—essential for making informed strategic decisions and accurately comparing your company to others in your industry.

What is NOPAT?

Net operating profit after tax shows how much profit your company would have generated from its operations if it had no debt. It measures how much your company profits from its primary business activities, after accounting for tax expenses but before considering the impact of interest expenses. By excluding interest paid, NOPAT provides a clearer view of your company’s operating efficiency and focuses on the performance of your core business operations.

The most common NOPAT formula is:

NOPAT = Operating Income x (1 - Tax Rate)

Where:

• Operating income (or operating profit) is the earnings remaining after operating expenses are deducted from revenue, excluding non-operating income

• Tax rate = The company’s effective tax rate, in decimal format

NOPAT example

The Sun Will Come Up Tomorrow is a hypothetical company that sells stylish chairs.

• The company’s operating income for the previous quarter was $750,000. This reflects the profit from the company’s operations (sales) without accounting for loan interest or income taxes.

• The effective tax rate is 20% (or 0.20).

Using the NOPAT formula:

NOPAT = $750,000 x (1 - 0.20)

NOPAT = $750,000 x 0.80

NOPAT = $600,000

This $600,000 represents the net operating profit after tax that the company generated solely from its chair business after tax expenses, completely independent of how the operations were financed (whether using debt or equity). This allows for an accurate assessment of the company’s performance.

NOPAT vs. NOPLAT

While NOPAT focuses solely on profit generated from core operations after taxes, there are other financial metrics that offer slightly more precision. Net operating profit less adjusted taxes (NOPLAT) is one such metric. The key difference between the two lies in how taxes are treated. Net operating profit after tax uses the standard effective tax rate on operating income, while NOPLAT accounts for changes in deferred taxes (taxes that are owed or overpaid with a refund due).

This makes NOPLAT a more refined measure for certain valuation models, like those that focus on free cash flow to the firm (FCFF), since they consider the cash impact of taxes more precisely. For most general analyses, NOPAT is sufficient, but NOPLAT can provide a more detailed look into tax implications. NOPLAT reflects the true cash tax rate on operating income, rather than just the statutory tax rate. This adjustment is particularly relevant for companies with significant deferred tax liabilities or assets, as it shows a more accurate view of the cash taxes paid on operating income.

What does NOPAT say about your business?

NOPAT offers insights into your company’s operational health. Financial analysts and business owners use it to understand how much profit a company truly generates from its main activities, independent of financing decisions.

Net operating profit after tax is important for several reasons:

• Assesses operational efficiency. NOPAT removes the distorting effects of interest expenses and provides a more accurate assessment of how well your company’s core operations are performing. A rising NOPAT indicates improved operations and profitability.

• Provides a more accurate comparison. You can use NOPAT to compare your operating performance with various companies, including those with different capital structures. This enables investors and financial analysts to make apples-to-apples comparisons regardless of how much debt a company carries.

• Assists with decisions related to valuation and investments. NOPAT is a critical input in many valuation models, such as free cash flow to the firm (FCFF). A higher NOPAT usually signifies a more valuable business, as it reflects stronger underlying earning power.

• Helps with strategic planning. You can use NOPAT to evaluate the effectiveness of your operational strategies. If NOPAT is not growing in line with revenue from sales, it might reveal efficiency issues—for example, with production.

Example of how businesses use NOPAT

Consider two hypothetical ecommerce apparel companies, Koala Bear Enterprises and Beta Alpha Inc. Both are in the same industry and have the same revenue and operating expenses, resulting in operating income of $1 million. However, Koala Bear Enterprises has significant debt, which has led to high interest expenses, while Beta Alpha Inc. is primarily equity-financed.

Koala Bear Enterprises’ net operating income may be lower due to its interest burden, making Beta Inc. appear more profitable. However, let’s calculate NOPAT (assuming a 25% tax rate for both):

• Koala Bear Enterprises NOPAT: $1,000,000 x (1 - 0.25) = $750,000

• Beta Alpha Inc. NOPAT: $1,000,000 x (1 - 0.25) = $750,000

NOPAT reveals that the two companies are equally efficient at generating profit from their primary operations. The difference in their net operating income is purely due to their financing structures, not their operational performance. This information would be important to an investor who wants to assess the underlying business strength rather than just the company’s financial health. 

How to calculate NOPAT

Calculating net operating profit after tax is straightforward, requiring primarily your company’s operating income and its tax rate. Here are two methods for calculating NOPAT:

Method 1: Using operating income

This is the most direct and commonly used method for calculating NOPAT:

1. Locate operating income. Find “operating income” or “operating profit” on your income statement. This is the profit generated from your company’s core operations before deducting interest expenses and income taxes. For example, assume your operating income for the last fiscal year was $1,200,000.

2. Determine the effective tax rate. Identify your effective tax rate—the actual percentage of income that the company pays in taxes. You can often find this in the footnotes to your financial statements or by dividing the income tax expense by pre-tax income on the income statement. Express this rate as a decimal for the calculation. For example, assume your company has an effective tax rate of 28% (or 0.28).

3. Calculate the after-tax retention factor. Subtract the effective tax rate (shown as a decimal) from one using this equation: After Tax Retention Factor = (1 - Tax Rate). This represents the proportion of operating profit retained after taxes are paid. For example: (1 - 0.28) = 0.72.

4. Multiply operating income by the after-tax retention factor. Multiply the operating income (from Step 1) by the after-tax retention factor (from Step 3) to arrive at the NOPAT calculation using this formula: NOPAT = Operating Income x (1 - Tax Rate). For example: NOPAT = $1,200,000 x 0.72 = $864,000.

This means your company has generated $864,000 in gross profit from its primary business operations after taxes are accounted for, regardless of its debt structure.

Method 2: Using net income and interest expense

You can use this method when operating income isn’t explicitly known or when you want to derive NOPAT from net income. It essentially adds back the after-tax impact of interest expense to net income.

1. Locate net income. Find your company’s net income on the income statement. This is the bottom-line profit after all operating expenses, including interest and taxes. For example, assume that your net income was $750,000.

2. Locate interest expense. Find your company’s interest expense on the income statement. This is the cost of borrowing money. Assume your interest expense was $150,000.

3. Determine the effective tax rate. As in Method 1, identify your company’s effective tax rate and express it as a decimal. Assume your company has an effective tax rate of 25% (or 0.25).

4. Calculate the tax-adjusted interest expense. Multiply the interest expense by one minus the tax rate. This calculates how much of the interest expense was offset by tax savings (since interest is tax-deductible). Use this formula: Tax-Adjusted Interest Expense = Interest Expense x (1 - Tax Rate). In this example, this is: $150,000 x (1 - 0.25) = $150,000 x 0.75 = $112,500.

5. Add tax-adjusted interest expense to net income. Add the tax-adjusted interest expense (from Step 4) to the net income (from Step 1) to arrive at the NOPAT calculation: Net Income + [Interest Expense x (1 - Tax Rate)]. Example: NOPAT = $750,000 + $112,500 = $862,500.

This calculation shows your company’s net operating profit after tax is $862,500, which represents operational profit after taxes before considering the impact of debt financing. This method is particularly useful when analyzing companies that may not explicitly report operating income, allowing you to “back into” the NOPAT figure.