Net operating profit after tax (NOPAT) is the results of a business before the impact of any financing arrangements are included. This means that NOPAT does not include the tax shelter provided by the interest expense associated with debt. Thus, NOPAT is useful for determining the operating results of a highly leveraged business. To derive net operating profit after tax, the formula is:
For example, if a company earns $100,000 from its operations and its tax rate is 21%, its NOPAT calculation is:
$100,000 operating earnings x (1 - 0.21 tax rate) = $79,000 NOPAT
NOPAT is considered a better measure of the underlying performance of a business than its net income after tax, since NOPAT excludes the effect of excessive debt levels that might result in large interest charges and offsetting tax effects. However, if a company has no debt, its net income after tax figure will match its NOPAT result.
A downside of using NOPAT is that it does not consider the effects of any financial engineering that the treasury staff may have incorporated into the capital structure of the business. Such engineering could be a significant competitive advantage, if it generates greater cash flow than what is available to competitors.
NOPAT is particularly useful for a potential acquirer, since the acquirer will likely replace the financing arrangements to which a target company is currently subjected, leaving it with the underlying NOPAT.
When calculating the NOPAT of a company, it is best to compare the result to the same calculation for other organizations within the same industry, so that the same cost structures can be compared. Some industries are inherently more profitable than others, so it makes less sense to compare NOPATs across industries.