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To understand what PAT is, let’s look at its definition first. Profit After Tax is the profit that remains after relevant taxes have been deducted. In India, PAT is declared in financial statements prepared in accordance with the Companies Act, 2013, and related accounting standards. This figure shows the actual earnings available for reinvestment or distribution and is widely used to assess a company’s real profitability and financial strength.
Key Takeaways
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PAT shows a company’s net earnings after all taxes are deducted.
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It helps assess profitability and financial health.
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PAT is used to analyse performance and compare results over time.
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It also indicates how much profit is available for dividends or reinvestment.
Difference Between Profit and Profit After Tax
Profit represents a company’s earnings before considering tax obligations and shows performance at an operational level. In contrast, profit after tax reflects the final income remaining after all applicable taxes are deducted.
This distinction matters because taxes directly affect how much income is actually available to the business. While profit helps evaluate operating efficiency, profit after tax provides a clearer picture of a company’s financial position and usable earnings.
Importance of PAT
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Measure of Financial Performance: PAT is a reliable indicator of a company's financial performance and profitability. It reflects the ability of a company to generate surpluses after accounting for all expenses and taxes. Stakeholders closely monitor PAT to evaluate the company's effectiveness in generating sustainable returns.
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Assessing Tax Efficiency: PAT reveals a company's ability to manage taxes effectively and determines if it meets its tax liabilities within legal frameworks.
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Basis for Dividend Distribution: PAT is an index for the stakeholders to determine how much profit is available for distribution. A higher PAT indicates a healthier financial position. It allows companies to allocate more funds for dividend payments.
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Benchmark for Comparisons: PAT can be used to compare the performance of the company you are considering investing in across periods and competitors. Businesses use PAT measurements to assess a company's performance over time and set sectoral benchmarks for comparison.
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Influencing Investment Decisions: PAT can significantly influence investment decisions as it reflects a company's financial health and ability to deliver a sustainable return. Investors use a growing PAT as an indication of financial stability and an attractive investment opportunity.
Also Read, What is Tax in India? Types & Tax Concept
What Is the Profit After Tax Formula?
The formula to calculate profit after tax is as follows:
PAT or NOPAT = Operating Income x (1-tax)
Where,
Operating income = gross profit - operating expenses
Another formula to calculate PAT is:
PAT = Net profit before tax - Total tax expense
Net profit before tax refers to the earnings of the company before deducting taxes. The total tax represents the amount of taxes paid or accrued during a specific period, including income tax, corporate tax, and any other applicable taxes.
Using the formula to calculate PAT, companies can determine their final profit available for dividend payment or reinvestment.
Calculating Profit After Tax: An Example
PAT is the resultant value of Profit Before Tax (PBT) minus the tax at the applicable rate. PBT is calculated by subtracting total expenses from total income. These expenses could be:
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Cost of goods sold
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Any depreciation
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Overhead and general expenses
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Interest paid on loans - short and long term
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Taxes are remitted to the government regularly
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Expenses incurred in the company's product research and development
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Charge-offs or expenses that are written off at one time or as losses
Here is a step-by-step breakdown and an example, to help you better understand how PAT is calculated.
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Step 1: Identify the company’s total revenue for the period and subtract all operating and non-operating expenses to arrive at profit before tax.
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Step 2: Determine the applicable tax rate based on the company’s legal and regulatory requirements.
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Step 3: Calculate the total tax amount by applying the tax rate to the profit before tax.
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Step 4: Subtract the tax amount from profit before tax to complete calculating profit after tax, which shows the final earnings available to the business.
Illustration of PAT Calculation
The tax rate is calculated based on the company’s geographical location. In India, the tax slabs vary across corporations - nature of ownership, size, type of business, etc. However, tax applies only when PBT is positive or when total revenue exceeds total expenses. Loss-making companies are not required to pay taxes.
Following is an example of a company's Profit and Loss statement with total revenue of ₹150,000.
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ABC Ltd. |
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Profit and Loss Statement |
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Revenue |
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1,50,000 |
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Less: Direct Costs |
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Cost of goods sold (COGS) |
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(25,000) |
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Gross Profit |
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1,25,000 |
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Less: Indirect Costs |
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Operating Expenses: |
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Selling |
15,000 |
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General |
5,000 |
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Administration |
15,000 |
(35,000) |
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Operating Profit/ EBIT |
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90,000 |
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Less: Interest |
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(10,000) |
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Earnings before Tax (EBT) |
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80,000 |
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Less: Tax |
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(10,000) |
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Net Profit/ PAT |
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70,000 |
The data is for illustration purposes only.
Read More About “The Ultimate Guide to Income Tax”
Advantages and Disadvantages of PAT
Advantages:
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Shows the company’s actual earnings after meeting tax obligations.
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Helps investors assess financial stability and dividend-paying capacity.
Disadvantages:
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Profit after tax can fluctuate due to changes in tax rates or laws.
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It may not fully reflect operational efficiency when analysed alone.
PAT Margin
The company’s net income after tax is divided by total sales to calculate the PAT margin. It is a critical financial ratio that tells investors about the profit made by the company for each rupee of revenue, and multiplying it by 100. PAT margin provides insights into the efficiency of a company’s management in generating profits after accounting for taxes. A higher PAT margin indicates better profitability and cost management, making it a crucial metric for assessing a company's financial performance.
Conclusion
Profit After Tax (PAT) is a crucial financial metric that indicates a company's profitability after deducting all taxes. It plays a vital role in assessing a business's financial health and sustainability. For publicly traded companies, changes in PAT value can indicate changes in the share price.
However, considering only the PAT or PAT margin when evaluating a company before investing may not give a complete picture. A company’s PAT can be reduced if tax rates are raised or the company earns less revenue, which may not provide the correct insight into business fundamentals and management.
