What is Profit After Tax and How is it Calculated? Why is it Important for Companies?
An essential step for all organisations is to ensure that they continuously monitor the amounts of profits and losses they incur during each fiscal year. However, the problem they face is that in addition to profit, the company also has to consider deductions, such as various taxes to the government, expenses, and pending liabilities.
There is a need to calculate profit free from taxation so that accurate profit information of a company can be calculated. Profit After Tax (PAT) is one of the many measures that provide an easy understanding of the profits to the company.
In this article, we shall dig deeper into this topic and understand the significance, calculation, and advantages of calculating profit amount from the net profit before interest and tax.
What is Profit After Tax?
For a company, the net profit amount after tax usually refers to the amount that remains with the company after paying all its operational and non-operational expenses from the total profit received in one fiscal period. This net profit is then divided between the various shareholders of the company, kept within the company funds as retained earnings, or given to employees as bonuses and appraisals.
Investors of the company also use Profit After Tax to analyse the profits over time which also affects the stock prices of the organisation. Hence, PAT is a measurement which also acts as an indicator of company valuation
What is the After-tax Profit Margin?
After-tax Profit Margin is a financial measure that is a ratio calculated by dividing the net profit before tax by the company’s net sales. This is an essential measure that most companies calculate because it accurately points out how effectively a company can manage the cost incurred for its operations.
The higher the tax profit margin, the more efficiently the organisation is said to run. However, just because a company has a low after-tax profit margin does not mean it is not doing well. This ratio is only one of the many metrics and measurements that are considered to evaluate the efficiency of a particular business.
How Does After-tax Profit Margin Work?
A company generally calculates the net profit before tax by using the net profit before tax formula and then calculates the after-tax profit margin for a particular time.
A higher profit margin typically denotes that the company is managing to operate profitably, thereby providing its shareholders with more value. This ratio on its own does not represent the efficiency of the strategies used by the company or the comparison of performance. However, when combined with other measurements like the profit before income tax and profit before interest and tax, it can reflect the organisation’s overall health.
Not all industries have the same budgetary requirements and expenses, so their after-tax profit margins can be low. However, that does not mean the company is not performing well.
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What is the Significance of Profit After Tax?
The PAT is a crucial instrument for many companies that operate on a mid to large scale. Even for some small scale businesses, calculating the net profit helps them to manage expenses and gain greater clarity about their position in the market.
Some of the reasons why PAT is an important concept to understand and how it is significant to companies today are:
- PAT is a crucial financial metric that helps to track the growth or decline in a company’s retained earnings.
- It gauges an organisation’s capacity to turn a profit from its revenue.
- It is frequently used for margin analysis, especially when comparing businesses within an industry.
- Investors can assess a company’s ability to generate profits by calculating its PAT.
- It can also assist businesses by determining where they need to control their cost.
Things to Gather before Calculating Profit After Tax
When calculating PAT, you need to consider some factors. Complete knowledge about a financial instrument can better help companies and individuals understand their net profit amount more accurately. Some of the features of PAT are as follows:
- PAT is also known by many other terminologies such as Net Operating Profit After Tax (NOPAT) or Net Profit After Tax.
- When a company’s net profit lands in a 0 after calculating PAT from profit before income tax using the net profit before tax formula, it is considered a loss and therefore exempted from tax.
- Dividends paid to shareholders and PAT have a direct relationship.
Formula to Calculate Net Profit After Tax With an Example
The simple formula to calculate PAT is as follows:
Profit After Tax (PAT) = Profit Before Tax (PBT) – Tax Rate
Here’s an easy example. Let us assume there is a company with a revenue of Rs. 1000, the non-operational expenses of the company stand at Rs. 200, and operational costs stand at Rs. 100. The tax rate is also provided, which currently stands at 20%.
Based on the above information, it is easy to calculate the net profit before income and by finding the difference between non-operating expenses and operating expenses. We can now use net profit before tax calculation and the tax rate to get the PAT.
Hence, PBT = 1000 – 200 – 100 = Rs. 700.
Thus, PAT= 700-20% = Rs. 560.
How is Profit After Tax (PAT) Important to a Company?
The net profit calculation is of utmost importance to a company. This percentage, along with other factors in profit calculation in a business, helps it to determine the company’s financial position in the dynamic market. Some additional reasons as to why PAT is important are:
- It displays the success of a specific company. To put it another way, increased profitability (compared to the prior year or its competitors) denotes improved company prospects.
- Growth at the bottom-most line of the business determines a company’s growth. If the increase in profit after taxes is faster than the increase in sales, the business’s margin has grown in absolute terms, which suggests that it has more pricing power than its competitors.
- However, PAT decreases during weak economic phases because operational costs rise faster than revenue growth.
Advantages of Profit After Tax
Some of the advantages of PAT for businesses are as follows:
- Apart from determining overall company health, net profit is crucial when evaluating corporate success.
- It helps determine the margin, effectiveness of operations, leftover profit, and a company’s dividends.
- The distribution of dividends is also based on the calculation of net profit. The higher the PAT, the more dividend is received by shareholders.
Disadvantages of Profit After Tax
Although beneficial to companies in many ways, PAT is also known to have some disadvantages. They are as follows:
- The calculation of net profit is only done in the case of profits. Hence, any loss analysis cannot be done, leading to an inaccurate evaluation of the company in the market.
- In case of increased tax amounts or operational expenses, net profit decreases, leaving less profit and dividends for the shareholders of the business.
- A company can ensure better interest rates if money is borrowed from an external source rather than simply relying on the profits for growth and expansion.
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Tips to Calculate Profit After Tax
Here are a few tips for companies when calculating PAT for better efficiency and more accurate results:
- When calculating net profit, try to find the values of profit before income tax and profit before interest and tax using the profit before interest and tax formula to analyse the financial earnings of a fiscal year.
- When calculating the PAT for a listed company, use the per-share basis to determine the net profit shown on the business’s income statement.
- Comparing the profit margins of multiple years of the same company can help determine the profit increase over time and the amount of tax and expenses. This information is used to reduce unnecessary costs and improve profit.
Final Word
Profit After Tax is a measurement or instrument used to calculate a company’s net profit using profit before tax formula and other measures. An increased PAT means that the company’s performance is efficient financially, and the business’s profitability is high. However, a business can sometimes face losses that can occasionally decline profitability and gains. An alert evaluator must learn to understand the factors which can affect PAT.
FAQS
Ans. The other terms for profit after tax include Net Income After Taxes, Net Operating Profits After Deducting Tax, and Net Profit.
Ans. Absolutely. It helps companies evaluate their performance and understand their income statement more clearly and precisely. They are generally calculated using a profit before tax formula and other values like tax percentage.
Ans. Yes, net income and net profit are derived from the profit before interest and tax formula, and both figures, combined with other financial instruments, can help understand the company’s financial position.
Ans. The total amount that the company receives before deductions of tax, interest, and expenses is known as profit before tax. The net profit amount is calculated after deducting the costs, tax and interest amounts, and liabilities, if any.
Ans. Tax is a financial charge made compulsory by governments across the world. Taxes are the primary source of income for governments, and they are charged not only to organisations but also to all citizens of the country.
