Title: What is Profit After Tax (PAT) and How to Calculate,Its Importance in Business
Introduction:
Profit After Tax (PAT) is a crucial financial metric that measures a company's profitability after accounting for all taxes. It provides investors, stakeholders, and management with insights into the company's financial performance and its ability to generate profits while meeting tax obligations. In this blog post, we'll delve deeper into what PAT is, how it's calculated, and why it's essential for businesses.
What is Profit After Tax (PAT)?
Profit After Tax, or PAT, refers to the profit amount the company retains after meeting all its operational and non-operational expenses, liabilities, and taxes. It reflects the amount of earnings available to shareholders or for reinvestment in the business. PAT is a crucial financial ratio and is calculated on a per-share basis.
PAT is widely used as a key financial indicator by analysts and investors to evaluate a company’s financial performance and ability to generate sustainable profits. PAT is also known as Net Operating Profit After Tax (NOPAT) or simply Net Profit After Tax (NPAT).
Importance of PAT (Profit After Tax)
Measure of Financial Performance: PAT is a reliable indicator of a company’s financial performance and profitability. It reflects the ability of a company to generate surpluses after accounting for all expenses and taxes. Stakeholders closely monitor PAT to evaluate the company’s effectiveness in generating sustainable returns.
Assessing Tax Efficiency: PAT reveals a company’s ability to manage taxes effectively and determines if it meets its tax liabilities within legal frameworks.
Basis for Dividend Distribution: PAT is an index for the stakeholders to determine how much profit is available for distribution. A higher PAT indicates a healthier financial position. It allows companies to allocate more funds for dividend payments.
Benchmark for Comparisons: PAT can be used to compare the performance of the company you are considering investing in across periods and competitors. Businesses use PAT measurements to assess a company’s performance over time and set sectoral benchmarks for comparison.
Influencing Investment Decisions: PAT can significantly influence investment decisions as it reflects a company’s financial health and abilities to deliver a sustainable return. Investors use a growing PAT as an indication of financial stability and an attractive investment opportunity.
How to Calculate Profit After Tax (PAT)?
The formula to calculate profit after tax :
PAT or NOPAT = Operating Income x (1-tax)
Where,
Operating income = gross profit – operating expenses
Another formula to calculate PAT is:
PAT = Net profit before tax – Total tax expense
Net profit before tax refers to the earnings of the company before deducting taxes. The total tax represents the amount of taxes paid or accrued during a specific period, including income tax, corporate tax, and any other applicable taxes.
Using the formula to calculate PAT, companies can determine their final profit available for dividend payment or reinvestment.
Understand of PAT Calculation
Understanding the PAT formula will become easier with the help of an example. PAT is the resultant value of Profit Before Tax (PBT) minus the tax rate. PBT is calculated by subtracting total expenses from total income. These expenses could be:
1. Cost of goods sold
2. Any depreciation
3. Overhead and general expenses
4. Interest paid on loans – short and long term
5. Taxes remitted to the government regularly
6. Expenses incurred in the company’s product research and development
7. Charge-offs or expenses that are written off at one-time or as losses
Calculate Tax
The tax rate is calculated based on the company’s geographical location. In India, the tax slabs vary across corporations – nature of ownership, size, type of business, etc. However, tax only applies in the case of positive PBT or when total revenue exceeds the total expense. Loss-making companies are not required to pay taxes.
Following is an example of a company’s Profit and Loss statement with total revenue of Rs. 2,50,000.
Example of PAT(Profit After Tax)
ABC Ltd.
Profit and Loss Statement
Revenue 2,50,000
Less: Direct Costs
Cost of goods sold (COGS) (75,000)
Gross Profit 1,75,000
Less: Indirect Costs
Operating Expenses:
Selling 20,000
General 10,000
Administration 20,000 (50,000)
Operating Profit/ EBIT 125,000
Less: Interest (25,000)
Earnings before Tax (EBT) 100,000
Less: Tax (25,000)
Net Profit/ PAT 75,000
The data is for illustration purposes only.
How To Calculate PAT Margin
The company’s net income after tax is divided by total sales to calculate the PAT margin. It is a critical financial ratio that tells investors about the profit made by the company for each rupee of revenue and multiplying it by 100. PAT margin provides insights into the efficiency of a company’s management in generating profits after accounting for taxes. A higher PAT margin indicates better profitability and cost management, making it a crucial metric for assessing a company’s financial performance.
Conclusion :
Profit After Tax (PAT) is a fundamental financial metric that provides valuable insights into a company's profitability and financial stability. By understanding and effectively managing PAT, businesses can optimize their operations, attract investors, and achieve sustainable growth. As a comprehensive indicator of financial health, PAT plays a pivotal role in shaping strategic decisions and driving long-term success in today's competitive business environment.
However, considering only the PAT or PAT margin when evaluating a company before investing may not give a complete picture. A company’s PAT can be reduced if tax rates are raised or the company earns less revenue, which may not provide the correct insight into business fundamentals and management.