Net Profit (PAT) : Formula & Importance
How does a company decide whether it is successful or not? – Sales are an indicator of the success of your business. However, there is one more important measurement to look at – net profit of the business.
Net profit is a measure of the fundamental profitability of a company after accounting for all costs and taxes.
What is Net Profit?
Net profit also called as Profit after Tax (PAT) is the amount of money that is left after subtracting total business expenses from the company’s total revenue. In other words, it is a calculation that includes almost all financial transactions in your business.
Net Profit Calculation is:
Net Profit = Total Income – Cost of Goods or Services – Operating Costs – Other Expenses – Interest – Depreciation – Taxes
- Total Income = Revenue/ sales + income from other sources.
- Cost of Goods or services – Expenses on raw material, labour expenses, etc.
- Operating Expenses – Fixed costs which are not associated with the amount of work order a company is processing like rent, insurance, advertising, employee salary, etc type of expenses.
- Interest – Interest on any loans the company has taken
- Depreciation – Depreciating value of assets is also deducted
- Taxes – applicable taxes
Net Profit is also referred as bottom line of a company’s income statement.
Why is Net Profit important to any business?
- Any business should know and care about net profit as it demonstrates its success. In fact, it is a far more significant figure than revenues as there is no point making lots of sales that ultimately don’t generate a profit.
- PAT also gives us indications of the money available with any company for its shareholders (Maximization of Shareholders wealth- which is the prime objective of any company) and/or invests back into the business.
- PAT is used to calculate EPS (EPS = Net Profit / Total Number of shares)
Other Reasons Why Net Profit Is Important
These are not the only reasons why PAT is important since other groups also have an interest in the PAT of your business. This includes:
- Revenue – to calculate the amount of tax you must pay
- Banks and other creditors – banks and other organizations that loan to businesses use the net profit figure to get a better understanding of the business and to assess the suitability of the loan. In particular, the net profit will give them an indication of your ability to pay.
- Competitors – if you are a limited company, your competitors will be able to access your net profit by analyzing the return you submit to the tax authorities. This will give them a better understanding of your business and how successful it is.
- Investors and shareholders – PAT is crucial for the investors and shareholders of the comapny. A healthy and consistent PAT figure will give investors the confidence they will get a return.
Like any other accounting figure PAT can be manipulated. Hence one should look at how it has been calculated while picking a stock on this basis.
Let us look at the recent PAT results of Maruti Suzuki India.
Reference – Maruti Suzuki’s Net Profit latest results.
Net Profit appears on a company’s income statement and shows how profitable a company is. A company which consistently gives rising profits is a good bet for investment.
Net Profit is also referred as bottom line of a business’s income statement.