A clear understanding on the difference between NOPAT and net income is needed if you are to analyze the financial statements, especially the income statements, to study the performance of a business. The main aim of running a business is making a profit. In order to make a profit, the firm must strive to increase their income and minimize their expenses so that the income recorded at the end of the accounting period surpasses the expenses. There are many types of income that are recorded on a firm’s income statement in order to assess a firm’s performance at different levels. The article takes a closer look at two types of income: net income and net operating profit after tax also known as NOPAT. These two forms of income are quite different to each other and are calculated differently. The following article offers a clear explanation of each and highlights their similarities and differences.
What is Net Income?
Net income is the amount of funds that are left over once all expenses incurred in the business have been reduced from the income for the period. The net income figure appears on the company’s income statement. As net income is derived from reducing all expenses from income, the net income number offers a quick overview of the company’s financial health. Generally by looking at the net income figure one can determine whether the company has been profitable during its accounting period. However, there may be certain instances in which the company makes a net loss. This may not necessarily mean that the firm was not profitable and could be as a result of large investments or purchases. Expenses that are reduced in order to derive net income include salaries, electricity, rent, taxes, maintenance costs, fees, interest expenses, etc. The amount that is derived once all these are deducted is the funds that the company is left with as a profit. A company’s net income also represents the earnings per share of the company’s total shares. Hence, higher the net income, higher the shareholder’s earnings.
What is NOPAT?
NOPAT or net operating profit after tax as its name suggests removes the effect of tax from the equation and offers an accurate look at the earnings if the company had no debt. NOPAT offers a clear look at the operating efficiency of unleveraged firms, as it does not include the company’s tax savings. Companies that do not have debt have no interest expense and, therefore, their NOPAT is equal to the net profit. In other words, NOPAT is the amount of operating profit that would be available to shareholders after tax, if the company held zero in debt. NOPAT can be calculated in a few ways:
• NOPAT = Operating profit x (1 – Tax Rate)
• NOPAT = Net Profit After Tax + after tax Interest Expense – after tax Interest Income
• NOPAT = (1-Tax Rate)* EBIT
What is the difference between NOPAT and Net Income?
Firms maintain income statements in order to track the income and expenses of the financial year and to determine the company’s profitability. There are many types of income that are recorded on a firm’s income statement in order to assess a firm’s performance when taking into consideration different variables. Net income and NOPAT are two such types of income. Net income is fairly straightforward and is derived by reducing expenses from the whole income for the year. NOPAT, on the other hand, is calculated by removing tax effects from operating profit. NOPAT offers an accurate overview of the operating profit that the company’s shareholders would earn if the company did not have any debt.
Summary:
NOPAT vs Net Income
• There are many types of income that are recorded on a firm’s income statement in order to assess a firm’s performance at different levels. Two such types of income: net income and net operating profit after tax also known as NOPAT.
• Net income is the amount of funds that are left over once all expenses incurred in the business have been reduced from the income for the period.
• As net income is derived from reducing all expenses from income the net income number offers a quick overview of the company’s financial health.
• NOPAT or net operating profit after tax as its name suggests removes the effect of tax from the equation and offers an accurate look at the earnings if the company had no debt.
• NOPAT offers a clear look at the operating efficiency of firms that do not have debt.
Further Reading:
- Difference Between Gross and Net Income
- Difference Between Cash Flow and Net Income