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, since its primary focus is on earnings generated by operations. NOPAT is particularly effective when comparing the results of several companies in the same industry that employ different financing structures, since the results 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 financing structures.
However, NOPAT should not be used to compare companies in different industries, since the operations of these organizations will still have essentially different cost structures. Thus, the NOPAT of a capital-intensive manufacturing organization may be quite different from the NOPAT of a services business.
If a company has no financing costs or interest income, then NOPAT is the same as net income. Thus, NOPAT is not especially useful for a company that has little or no debt. In this situation, a simple net income calculation should be sufficient for interpreting the results of an organization.
The formula for NOPAT is as follows:
Net operating income x (1 - tax rate)
For example, a business has revenues of $1,000,000, cost of goods sold of $650,000, administrative costs of $250,000, and interest expense (on a heavy debt load) of $100,000. Its tax rate is 35%. The company's income statement reveals net profits 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 $65,000.