Does your small business have equity shareholders and debt holders? If so, you might want to start calculating your business’ net operating profit after tax. NOPAT is a measure of a company’s after-tax profit that investors use as a way to compare the financial results of the business over time and against competitors. It’s also used in calculations of economic value added, which is the financial return your business earns over minimum required return. You might also see NOPAT used in free cash flow calculations.
Your business’ NOPAT is an important number because it shows your theoretical income from operations if the business had zero debt and no interest expense. Investors, lenders, and other stakeholders find NOPAT useful because it makes companies more comparable by removing any impact of their capital structures. That’s why if your business has debt holders, it’s a good idea to have a NOPAT calculation ready to show at a moment’s notice.
It takes just three easy steps to calculate NOPAT. Step one is to start with your earnings before interest and taxes, which you likely already calculate on your income statement. The next step is make a few adjustments to relevant items on your income statement. You need to eliminate any distortions in the numbers caused by accounting practices. Basically, you need to covert accrual accounting numbers to cash basis accounting numbers. You might need to also reclassify some expenses as investments and move them over to your business’ balance sheet. This is known as capitalization. The third and final step is to subtract cash operating taxes.
NOPAT is a very useful measure of a business’ financial return that investors, debt holders, and stakeholders can use to compare the business’ results to its past history and competitors. The calculation of NOPAT takes only three steps, but depending on the complexity of your business, can be a challenge. It might be a good idea to consult with an accounting professional when calculating NOPAT.