NOPAT stands for Net Operating Profit After Tax and represents a company’s theoretical income from operations if it had no debt (no interest expense). NOPAT is used to make companies more comparable by removing the impact of their capital structure. In this way, it’s easier to compare two companies in the same industry (i.e., one with no leverage and the other with significant leverage).
This guide will break down everything you need to know about Net Operating Profit After Tax.
The NOPAT formula is as follows:
Income from Operations x (1 – tax rate)
[Net Income + Tax + Interest Expense + any Non-Operating Gains/Losses] x (1 – tax rate)
NOPAT Calculation Example
Here is an example of how to calculate Net Operating Profit After Tax.
Please have a look at the sample income statement below, which we will use for the calculation.
As you can see in the example above, in 2017 the company has Net Earnings of $2,474 and a NOPAT of $4,195. Let’s look at the difference between these numbers.
Operating Earnings represents the company’s profit before interest and taxes, so it shows us what the company would earn if it had not debt (no interest expense). From there, we can calculate a new theoretical tax expense by multiplying $6,094 by one minus the tax rate assumption of 31% (this is what the actual tax rate was in the year).
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Use of NOPAT in Financial Modeling
In financial modeling, Net Operating Profit After Tax is used as the starting point for calculating unlevered free cash flow (a.k.a.free cash flow to the firm FCFF).
The most common approach to valuation is to calculate a firm’s enterprise value (as opposed to its equity value) so that the capital structure of the business is ignored, and only the firm’s assets are used for determining its value.
As you will see in the example below of a DCF model, the “Discounted Cash Flow” section starts with EBT, adds back interest expense, and arrives at EBIT, which is the equivalent of Operating Profit. From there, “cash taxes” are deduced, which is based on multiplying Operating Profit (EBIT) by the tax rate.
Difference Between NOPAT and Unlevered Free Cash Flow
NOPAT does not take into account changes in net working capital accounts such as accounts receivable, accounts payable, and inventory. Additionally, it includes depreciation and amortization (a non-cash expense) and doesn’t include capital expenditures (an actual cash expense). For these reasons, Net Operating Profit After Tax can be materially different than Free Cash Flow.
To summarize, NOPAT has the following traits:
Does not include changes in net working capital
Includes non-cash expenses such as depreciation and amortization
Does not include capital expenditures
To learn more, see our cash flow guide which breaks down the cash flow calculations with lost of examples.
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