NOPAT: What it is and how to calculate it

Use the net operating profit formula to compare your business’s performance to past years and assess how your company stacks up against competitors. Net Operating Profit After Tax (NOPAT) shows a firm’s after-tax profits from day-to-day business operations and provides key insights, allowing business owners to capitalize on lucrative opportunities.

Keep reading to learn what NOPAT is and how the calculation differs from net income, EBIT, and other balances. We will assess Seaside Furniture’s income statement and teach you how to calculate NOPAT, and how to use the formula to create reports and make smart financial decisions.

• NOPAT definition
• Importance of NOPAT data
• NOPAT Formula
• How to interpret NOPAT margins

What is NOPAT?

In the world of corporate finance, investors and shareholders use the NOPAT (Net Operating Profit After Tax) formula to measure a business’s theoretical income after all taxes, interest, and expenses have been withheld. 

It shows how much a company could make if it didn’t have any debt—this is called unlevered free cash flow. 

What is operating profit?

Operating profit accounts for all gross profits earned through business operations before interest and taxes are deducted. 

The operating profit is the amount left over after operating expenses (OpEX) get deducted from a business’s gross revenue. 

Why is NOPAT important and what can the data tell you?

NOPAT is a great indicator of how well a company uses assets to generate profits for core operations. Once you complete your NOPAT calculations, you can use the data to develop strategies that increase operating profit. 

Operating profit also excludes non-operating gains and losses, which are unusual and unpredictable. By focusing on operating profit, an analyst can get a clear picture of profitability.

What’s the difference between EBIT and EBITDA? 

Now that we’ve introduced you to the concept of net operating profit, let’s break down how it differs from EBIT and EBITDA. 

Both measure a business’s profitability using net income before taxes, but that’s where the similarities end. 

• Earnings Before Interest and Taxes (EBIT): Net income before taxes and interest are deducted. 
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): Net income before taxes and interest gets deducted, excluding amortization and depreciation. 

What are non-operating activities? 

Non-operating activities include one-off events that affect cash flow and fall outside the scope of normal business operations. 

Some examples of non-operating activities include:

• Paying off interest on debt
• Restructuring your business
• Writing off inventory
• Paying a settlement
• Relocating your center of operations

These are also known as Capital Expenditures (CapEX) because they encapsulate broad, long-term expenses rather than expenses for daily operations. 

Advantages of NOPAT

NOPAT is a useful metric for businesses that want clear insights about their profitability and operating efficiency for investors. It better illuminates business performance by eliminating debts, interest, and taxes that would otherwise skew revenue numbers.

Disadvantages of NOPAT

NOPAT isn’t the best metric for a business’s internal use because it doesn’t consider debts and other expenditures. When considering real-life operations rather than just underlying performance, it’s important to calculate Net Operating Income (NOI) to see the whole picture. Otherwise, you run the risk of making poor financial decisions.

Formula: How to calculate NOPAT

NOPAT is calculated by using a year’s worth of income to determine a business’s profits without the impact of debt. The full steps we outline below include:

1. Two formulas for calculating NOPAT 
2. How to find your operating profit

1. Choose the right NOPAT formula

There are two formulas you can use to calculate Net Operating Profit After Taxes. Both calculations yield the operating profit based on after-tax dollars. 

A. More complex NOPAT formula

You should use the first version if you are unsure how much operating profit your business earned before interest and tax deductions.

NOPAT = (Net income + non-operating income loss – non-operating income gain + interest expense + tax expense) x (1 – tax rate)

B. Simpler NOPAT formula

The second formula is the easiest way to calculate NOPAT because it requires fewer steps. However, you can only use this formula if you already know your business’s operating profit.

NOPAT = Operating profit x (1 – tax rate)

2. Use an income statement to find operating profit

If you’re using Quickbooks, it’s easy to find your operating profit. Just navigate to the “Reports” tab and scroll down to “NET OPERATING INCOME” on your income statement. 

If you prepare your own income statements, you will need to calculate this yourself using this formula:

Revenue - operating costs - Cost of Goods Sold (COGS) - daily expenses = Operating profit

3. Begin the calculation

Once you know your operating profit, multiply the net operating income by one minus the tax rate to find the NOPAT. 

Is depreciation included in NOPAT?

Yes, depreciation is included in the NOPAT calculation.

4. Take your taxes into consideration

Next, you will need to account for taxes. Your tax rate will vary depending on a number of factors including business location, structure, and income. If you need help verifying your tax rate, contact a tax advisor for assistance.

NOPAT calculation example 

As an example throughout this article, meet Patty, the owner of Seaside Furniture, a manufacturing company. Let’s say this is Seaside’s 2022 income statement:

Note: The income statement above uses the term operating income, which also means operating profit. This discussion will use operating profit.

1. Choose the right NOPAT formula: We can use the simple NOPAT formula for our calculations since we already have the operating profit listed on our income statement. However, for the sake of this example, we will walk you through the complex formula.
2. Use the income statement to find operating profit: You’ll note that the operating profit (i.e. $200,000) is listed on the income statement. If you don’t see this on your income statement, you can calculate the operating profit on your own using this formula:

Revenue - cost of goods sold (COGS) - operating expenses - depreciation - amortization = Operating profit

If we were to calculate Seaside’s operating profit, it would look like this:

1,000,000 - 600,000 - 180,000 - 20,000 = 200,000

In this instance, there was no amortization so the final operating profit is $200,000. 

1. Calculate the NOPAT: Now, we can plug Seaside’s operating profit into the simple NOPAT formula.

NOPAT = Operating profit x (1 – tax rate)

Assuming that Seaside’s tax rate is 25%, we can complete our calculation. 

 ($200,000) x (1 - 25% tax rate), or $150,000

We can further break down this calculation to $200,000 x .75 which equals $150,000. That means that Seaside’s operating profit is $150,000. 

How can the income statement and NOPAT calculation can be used:

After assessing Seaside’s income statement, we determined that they could potentially boost their operating profits in three key ways:

• Sale price: Increasing sale prices can increase profits.
• Reduce costs: The firm’s $600,000 cost of goods sold balance, for example, includes material and labor costs. If Seaside can negotiate lower material costs or pay a lower hourly labor rate, profits will increase.
• Gain efficiency: Businesses can work more efficiently by embracing technology. Accounting software can help a firm post accounting transactions and create invoices in far less time, which reduces costs.

NOPAT margin calculation example

Using the NOPAT we calculated earlier, we can calculate Seaside’s NOPAT margin to find a percentage that accurately represents how efficiently the business generates profits from daily operations without the burden of debts or taxes. 

Some analysts prefer to use the NOPAT margin formula to calculate the profit associated with each dollar of sales. The NOPAT margin formula is:

 (NOPAT) / (Total revenue) = NOPAT margin 

When we plug in those numbers from Seaside’s 2022 income statement, we can determine that the NOPAT margin for Seaside is 15%. 

 ($150,000) / ($1,000,000) = 15%

The margin calculates the amount of profit earned on each dollar of sales. If a business can increase its margin, the firm will be more profitable.

This formula is similar to profit margin, which is (net income) / (revenue). Seaside’s profit margin for 2022 was ($138,000) / ($1,000,00), or 13.8%. The profit margin ratio is lower because net income includes more expenses than operating profit.

How do you interpret the NOPAT profit margin formula?

The NOPAT formula can also provide insights regarding anything related to profitability after tax. For example, you can:

• Assess how much taxes increase when there is no debt: The NOPAT formula removes the impact of debt and the tax savings of carrying debt. This is important because when businesses don’t carry debt, their tax expenses are generally higher.
• Measure profitability: Determine a business’s earning potential without the impact of expenditures and non-operating income. 
• Compare profitability of multiple businesses: Investors can use the NOPAT formula to compare two or more businesses and select the option that is likely to yield the highest profits. 
• Equipment valuation: Determine the market value of a business’s equipment without the impact of loan debt or interest. 

To give a bit more context, we’ve covered two of these scenarios below.

Scenario 1: Investor assessment of competing businesses 

Assume that Premier Furniture is a Seaside competitor, and also generated $1 million in revenue during 2022. However, Premier carried $500,000 in debt. You can compare the profitability of Seaside and Premier using operating profit.

Let’s assume that Jill owns a $10 million furniture manufacturing business, and wants to purchase either Seaside or Premier. To assess profitability, she as an investor can use NOPAT to compare the profitability of the two firms.

Operating profit reveals how each company generates a profit from normal business activities. Gains and losses on asset sales are unusual, and the level of debt may vary greatly over time. NOPAT excludes these variables from the formula.

The operating profit and net income balances are also different.

Scenario 2: Interest gain on sale of equipment

In 2022, Seaside had a $300,000 loan with 6% outstanding, and paid the required $18,000 interest expense. 

With NOPAT, we can see the $2,000 gain Seaside made on the sale of equipment without the burden of non-operating income and expenses from earnings before tax. Both the interest expense and the gain from the sale of equipment fall under the non-operating category.

NOPAT vs. free cash flow

NOPAT does not account for working capital or capital spending, and the formula calculates profitability before considering depreciation expense and tax expenses. 

That’s why some analysts prefer the free cash flow calculation, which sets aside dollars required for working capital and capital spending. Free cash flow assumes that working capital must be set aside for business operations, which is why the balance is subtracted from the cash flow total.

This is the formula to calculate unlevered free cash flow from your business’s net income:

Free cash flow = Net income + depreciation/amortization – change in working capital – capital investments

Capital is any money invested in a company to purchase assets or operate the business. Every firm uses assets to generate revenue, and assets must be properly maintained and eventually replaced.

• Depreciation expenses: The value of an asset after a given amount of time passes. 
• Amortization: The amount of money paid toward a loan’s principal and interest.
• Taxes: The mandatory financial contributions withheld by government agencies. 
• Working capital: Money available for immediate, short-term operational obligations. Financially healthy firms have a positive working capital balance, meaning that current assets are greater than current liabilities.
• Capital investments: The acquisition of property or loans.

Advanced finance reporting at your fingertips

When sorting through dozens of financial reports, picking out actionable data that helps you make smart business decisions can feel overwhelming. So what do you do after you calculate your NOPAT?

Leveraging a small business financial dashboard like QuickBooks Online can provide advanced insights to monitor your operational expenses and income to help you prepare for LBO and DCF modeling.