How to Calculate Profit After Tax and its various implications

The collection of taxes is the government’s primary source of revenue in India. Firms, individuals, domestic companies, foreign companies, and so on all have different tax rates. In India, there are a variety of taxes that are split into two categories: direct taxes and indirect taxes. Wealth tax, corporate tax, and income tax are examples of direct taxes, whereas excise duty, customs duty, goods and services tax, and other indirect taxes are examples of indirect taxes. Businesses need to track their profits to assess their success and possibilities for expansion. Certain elements, like taxes, debts, and expenses, may, however, impact their profitability. Net profit after Tax is an easy-to-understand financial measurement for evaluating an organization’s profitability over a certain period.

We define net profit after Tax, detail the processes for computing net profit after Tax, present an example calculation, and discuss various applications for this financial measurement in this article.

What are Profits?

A profit is a financial gain derived from all commercial activity for any company. It is the excess of returns over all of the company’s or business’s net expenses. Every business attempts to increase profits by lowering expenses or raising selling prices. Profits made by a firm are frequently re-invested in the company or distributed as dividends to its shareholders.

Profit margins are divided into four categories:

• Gross Profit
• Operating Profit
• Pre-Tax Profit
• Net Profit or Profit after Tax

Did you know? The Net income after taxes or the profit after taxes is one of the most analysed figures in the financial statements of a company.

What is net profit after Tax?

Net profit after Tax (NPAT) is a financial indicator that shows how profitable a company’s primary business is. It does not include any tax benefits that a business may obtain as a result of its current debt, as well as one-time losses or charges, such as acquisition-related expenses. Because one-time charges do not accurately reflect an organization’s underlying profitability, net profit after Tax removes them. Organizations frequently use net profit after Tax with economic value added (EVA). As a hybrid computation, it may provide information into the company’s performance and operational efficiency without the influence of leverage.

Similarly, analysts may utilize net profit after Tax to perform additional cash flow estimates. This may aid in determining the organization’s development and cash flow potential in the absence of debt.

The formula for Profit after Tax

PAT’s formula can be summarised as follows:

Profit After Tax (PAT) = Profit Before Tax (PBT) – Tax Rate

Profit before Tax:

It is calculated by subtracting total expenses (including operational and non-operating) from total revenue (operating revenue and non-operating revenue).

Also read: 3 Golden Rules of Accounting, Explained with Best Examples

Taxation:

Taxation is based on PBT, and the rate of taxation is determined by the country’s geographical position. In India, for example, the taxation slab varies across corporate enterprises, individual ownership firms, and salaried personnel.

Profit after-tax, often known as net profit, is calculated by subtracting the taxable amount from PBT. The taxable component is not necessary in the case of a negative profit before Tax (where total expenses exceed total revenue). Tax is only applicable in the case of profitability.

The net income must be reduced by expenses and costs. The following are some of the deductions:

• Cost of goods sold
• Depreciation
• Overhead and general expenses
• Interest expense on any debt, including short-term debt and the interest portion of long-term debt, such as bonds issued, is subtracted from net operating earnings.
• Taxes are remitted to the government on a regular basis.
• Costs associated with the company’s product research & development.
• Charge-offs –  these are expenses that can be written off at one-time or as losses.

The profit after taxes for a wholesale company with ₹ 1,00,000 in revenue are shown in the income statement below –

Also read: All About Tax Deducted At Source

PAT Margin (%)

Net profit after taxes is divided by total sales to calculate profit margin. This is an important basic measure since it informs investors how much money the company makes every rupee of revenue. The management’s efficiency in generating profit from sales after meeting operating and overhead expenditures is measured by the net profit margin.

It is assumed that a firm’s PAT growth margin is improving on a quarterly or annual basis, indicating that the company is doing well.

Advantages

• PAT aids in determining the health of a company. It is a significant criterion for shareholders to evaluate business performance.
• PAT calculates the profit margin, operating efficiency, and remaining profits, as well as dividends, which are paid after all expenses have been paid.
• A higher PAT indicates a business’s higher efficiency, whereas a lower PAT shows a business’s ordinary or below-average operational efficiency.
• Dividends are distributed in direct proportion to PAT. The dividend yield would be higher if the amount was bigger.
• The stock price of a company is likewise influenced by PAT, as profit growth aids stock price appreciation and vice versa.
• The government of the particular company receives the taxable money as a result of its profitability that is used for the development and progress of the separate countries. Payment of dividends to shareholders is the company’s way of sharing their profits and thanking the shareholders for their trust in the company and their support. 

All of the preceding conditions are met in the case of profitability, or when income is higher and expenses are lower.

Disadvantages

• If the tax rate is raised, the company’s net profit after Tax, or bottom line, falls, leaving less money for the shareholders as well as “reserves and surpluses.”
• Losses result from inefficient operations. As a result, the management, business model, and cost-effectiveness of the company are all in question.
• Only in the case of profitability is it calculated. Tax is not applicable during losses, hence the firm is not viable during continual losses.

Also read: Know About Paying Taxation of Income Earned From Selling Shares

Significance of PAT in share market

When a corporation is publicly traded, the profit after tax margin (PAT) is used to indicate how any change in the value can manipulate the stock prices. Profit after Tax is determined on a per-share basis if the company is publicly traded, and it appears on the income statement.

Importance of PAT in accounting

Profit after Tax is a crucial metric that is used in ratio analysis to determine a company’s profitability. PAT is determined on a share basis in the case of a publicly-traded firm, and this information is used to evaluate the value of the company’s stock. A high PAT number indicates strong efficacy and can entice more investors to acquire stock.

Profit after Tax is a financial ratio used by both investors and creditors to determine whether a company’s activities are profitable or not. Even though it is not an accurate measurement, it is frequently used as a gauge.

The PAT analysis can also be used to determine a company’s operational efficiency without having to look at its financial structure.

Calculating the Profit after Tax is critical for understanding the actual amount that a firm makes in a given working year. The profit after tax index also aids the company in determining whether it needs to cut costs.

Companies’ profit after taxes is obtained and examined to create reports that allow for healthy comparison and analysis amongst companies. A high PAT shows that the company is profitable. A large profit margin translates to higher dividends for equity shareholders. If the Profit after Tax statistic is negative, the company is losing money. As a result, the money cannot be taxed.

What are the factors that affect Profit after Tax?

Numerous factors influence a company’s profits and profitability. These variables can be qualitative or quantitative.

The quantitative factors are often identified easily and changed as per needs. These include – 

• Sales revenue
• Production / Manufacturing costs
• Inventory numbers
• Taxation.  

The amount of profitability of a corporation is heavily influenced by sales revenue. Another crucial component in a company’s capacity to sustain a high level of profitability is cost management. Inventory values are also important. Depreciated inventory can result in a reduction in profit margins, which can be detrimental to the organization. Increased inventory sales will result in larger profit margins.

Taxation is an external component that influences the profit after tax level. To obtain cash for specific government expenditures, governments levy forced taxes on persons or organizations. Taxation continues to have a significant impact on net income.

Various qualitative aspects influence Profit after Tax. These factors include the sale of a product, market share value, successful advertising, changes in client preferences, firm leadership, employee training programs, sales incentive programs, seasonal variations, advertising level and effectiveness, and market competition strength.

Also read: What is the List of Accounting Standard

Conclusion:

Profit after Tax is the revenue that a company avails of after meeting all its expenses. Higher profitability equals higher PAT, while lower profitability equals lower PAT. However, unusual decreases or increases in profitability, or even losses, might occur as a result of exceptional item losses or profits.

A tax rebate may be adjusted, and a refund added to the loss amount in some situations, resulting in a reduction in losses. PAT is the most important feature of any corporation because it defines the future of the company. After all, the remaining profits are used to fund capital expenditures. 

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