The net profit of a company is often the first point of reference when considering it as an investment option or under a loan application. Also known as the bottom line of an organisation, the ultimate motive of any business is to increase its profits. While there are many factors that affect the ultimate profit available for distribution to shareholders and retention within the business, taxes play a significant role. Therefore, profit after tax is the accurate measure of profit for a business. So how is this calculated and why is it given so much importance? Read on to get answers to these questions and learn more about profit after tax.
Read More: Gross profit margin – All you need to know
What is PAT?
Profit after tax refers to the net profit of a business entity after considering all the incomes and expenses for a financial year or any interim period in question. This includes all the operating and non-operating incomes and expenses during such periods. Profit after tax or PAT is considered to be one of the most crucial barometers of evaluating the performance of a company. It can be used to compare the company’s performance with its historical data and with its peers in the industry. A consistent increase in the PAT margin is further considered to be a sign of a growing business while on the other hand, a stagnant or declining PAT margin is considered to be one of the first red flags for a business and its stakeholders.
How is Profit After Tax calculated? Explain with example
The formula to calculate Profit After Tax (PAT) is given below.
PAT = (EBT) – (Tax Expense)
Where:
EBT = Earnings Before Tax
Tax Expense = Income Tax Expense
Let us consider the following example to understand the concept of profit after tax in detail.
Consider the following data of Company XYZ Limited.
The company has revenue of Rs. 10,00,000 for FY 22-23 and the cost of goods sold amounting to Rs. 6,00,000. The operating expenses of the company for the year amount to Rs. 2,00,000 and the interest income and taxes for the year are Rs. 40,000 and Rs. 50,000 respectively. Now let us calculate the Profit After Tax or the net profit of the company for FY 22-23.
| Particulars | Rs. |
| Revenue | 10,00,000 |
| (-) COGS | 6,00,000 |
| Gross Profit (Revenue- COGS) | 4,00,000 |
| Operating Expenses | 2,00,000 |
| Operating Profit (Gross Profit – Operating Expenses) | 2,00,000 |
| (-) Interest Income | 40,000 |
| Earnings Before Taxes (EBT) | 1,60,000 |
| (-) Taxes | 50,000 |
| Profit After Tax | 1,10,000 |
In the above example, we calculated the Net Profit or the Profit after tax of the Company XYZ Limited using the given data and the formula for Profit After Tax.
This profit amount can be further used to calculate the profit margin of the company for FY 22-23
Net profit margin of XYZ Limited = (Profit After Tax / Revenue) * 100
Therefore, Net profit margin of XYZ limited = (110000/1000000) * 100
Net Profit Margin = 11%
Why is profit after tax important?
As mentioned above, profit after tax is considered to be among the important indicators of the financial health of a business. It can be used to understand financial information from the point of view of diverse stakeholders. Given here is a brief example of the same.
For investors, lenders, and other stakeholders
- PAT helps investors assess the profitability of a company and determine the potential returns on their investment.
- It provides valuable insights into the financial health of a company which further helps the stakeholders in evaluating the risk associated with their investment.
- Lenders use PAT to evaluate a company’s ability to repay loans, making it crucial in assessing creditworthiness.
For company
- PAT allows a company to measure its financial performance and profitability over a specific period as well as determine the amount of profits that are ultimately available to be distributed to the shareholders in the form of dividends.
- Analysing PAT can help in budgeting, resource allocation, and financial decision-making for the company as well as determining the actual tax liability.
- PAT indicates the ability of the company to generate profits, which is vital for its long-term sustainability and growth.
- A consistent and healthy PAT ratio can attract investors, lenders, and potential partners, providing a competitive advantage and increased potential investments for the company and leading to enhanced trust among different stakeholders.
What are the pros and cons of using PAT?
The different pros and cons of using PAT are tabled hereunder.
| Pros | Cons |
| Profit after tax is the basis for calculating many financial ratios and assessing the health and profitability of the company. | Profit after tax is affected by a number of factors and can be easily manipulated. |
| A consistently growing PAT margin can have a positive impact on the stock price of a company. | Profit after tax cannot be used to measure companies or businesses belonging to different industries or sectors. |
| A positive profit after tax also helps in evaluating the ability of the management to meet the objectives of the business and take it forward on the growth path. | PAT is highly dependent on the tax policies of a nation and any significant change in the same can lead to drastic changes in the future plans or growth outlook of the company. |
Conclusion
Profit after tax is the final level of profitability in the income statement of a company or a business organisation after considering all the expenses and taxes. However, it can be easily manipulated to show better performance to attract investments or borrowings. Therefore, it cannot be treated as the sole point of consideration for making investment decisions or used on a standalone basis. It is important to evaluate it using historical data to get an accurate analysis of the financial health of the company and its future prospects.
FAQs
The profits of a company are taxed based on the net taxable income after considering all the applicable deductions and exemptions at a tax rate of 25% or 30% depending on such income.
The formula to calculate EPS uses profit after tax in the following manner.
EPS = Profit after Tax or Net profit / Outstanding Number of Shares
Some of the factors that affect profit after tax include the changes in accounting policies, total income (operating and non-operating), cost of goods sold, operating and non-operating expenses, interest expense, depreciation and amortization, extraordinary items, pricing strategy, competition, and more.
A consistent increase in the profit after tax indicates the ability of the business to generate more net income after paying for all its expenses and applicable taxes as well as its efficiency in meeting a healthy growth margin.
