When managing your finances, whether for yourself or your business, there are a few essential terms you must understand. One of the most important is Profit After Tax (PAT). If you’re wondering what PAT is, why it is significant, and how to calculate it, this article is for you. Let’s start!

Understanding Profit After Tax & Its Importance

PAT is the amount you’re left with after subtracting all expenses, including depreciation, taxes, interest, and operating costs, from your total revenue over a financial year.

When it comes to taxes, this includes everything from personal income tax to corporate taxes and any other applicable levies. Your earnings after tax give a more accurate picture of what’s actually been earned over the financial year. Many people rely on this figure as a key indicator to assess whether financial goals or performance targets have truly been met.

Now that you understand why PAT is such a crucial indicator, it’s worth exploring why it holds so much value across industries. Here are some key reasons why it is viewed so favourably:

  1. For Distribution of Dividends: A lot of organisations often use PAT as the basis for how much dividend is to be distributed to the people who have equity in the company, i.e. the shareholders. The higher the Net earnings, the more that is potentially available to shareholders, which makes the company more attractive to shareholders. Even if it’s not distributed as a dividend, it can be reinvested in the business, which increases the value of the stock. 
  1. From an Investment Point of View: With earnings after tax reflecting a company’s financial health, PAT can be quite influential when it comes to driving investment into a company. A high number can have a positive impact on people who are looking to invest; on the other hand, if the number doesn’t quite stack up against companies operating in the same sector, potential investors may look elsewhere.
  1. Ability to Deal with Taxes: By looking at the figure, you can estimate how a company has been dealing with the taxes it has to contend with. If the number is high, you know that the management has been effective in dealing with its tax liabilities and operating more or less to its optimum. On the other hand, if the number is on the lower side, you know that there is scope for improvement.
  1. For Making Comparisons: PAT can be an excellent metric when it comes to making comparisons between two or more companies operating in the same sector. You can look at the net income and determine which one represents a better opportunity when it comes to investing. Of course, there may be outliers in some years that you might have to evaluate as well. 
  1. Indicator of Performance: This metric is a very reliable indicator of the performance of the company. It presents a complete story as to how a company has performed and provides information for analysing the performance in a financial year.

How to Calculate Profit After Tax

Having talked about how crucial this indicator is for a company, it is relevant to know how to calculate Profit after Tax. So, there are a couple of ways to calculate the metric, let’s look at the formula and then understand the same with the help of an example. 

The formula for calculating is:

PAT = Net income before Tax – Tax liabilities of a company

Here we arrive at the net income before tax by subtracting operating and non-operating expenses from the revenue earned.

Why PAT Matters to Investors and Businesses

Earnings after Tax, or Net Income, is an important metric that tells us a whole lot about a company and how it has been doing. The metric in itself has a lot of advantages; it can boost the confidence of an investor when it comes to investing in a company. A high PAT can certainly drive investment, especially if an organisation has shown that it can put up consistent numbers year-on-year. 

PAT can also improve the liquidity position of a company and reduce its reliance on outside borrowings, like loans. Given that there is no or very little debt to be serviced is always a good sign for a business. Another positive of PAT is that it elevates the ability of the management to make good decisions, which can improve the performance in the medium to long term. 

The Limitations of Relying Solely on PAT

Even though Profit After Tax comes with several advantages, it’s not a one-size-fits-all metric. You need to use it carefully, especially when comparing companies across different sectors. For example, a company in healthcare may naturally operate under a very different cost structure than one in fast-moving consumer goods (FMCG), making direct comparisons through PAT misleading.

High net profit might also influence shareholder expectations. Investors could start demanding higher dividends, which might pressure the company to prioritise short-term gains over long-term growth.

Moreover, PAT is sensitive to changes in tax laws and rates. A policy change in your country could skew PAT figures, making year-to-year or cross-company comparisons less reliable. In years when a company posts losses, perhaps due to such policy changes, PAT may not be the most useful tool for assessing performance.

PAT as a Reflection of Financial Health

Despite its limitations, PAT remains one of the most important indicators of a company’s financial health. It sheds light on how well an organisation has been doing and helps in arriving at investment decisions. You can compare companies operating in the same sectors to choose the best option via their PAT numbers. For instance, we will arrive at better decisions by comparing two companies operating in the healthcare sector, rather than comparing one in healthcare to one that is involved in the Fast-moving Consumer Goods (FMCG) sector. 

Many organisations also base their dividend policies on net income figures. So, understanding how PAT is calculated gives you an edge in interpreting financial statements and assessing a company’s long-term potential.

Conclusion

Understanding metrics like PAT is just the beginning. If you want to explore detailed company data, compare sector-specific performance, and invest with confidence, head over to Share.Market. Start your investment journey with the right tools and insights today.

FAQs

1. How does one calculate Profit after Tax?

To calculate profit after tax one needs to deduct operating expenses, taxes, interest costs and depreciation from the revenue earned in a financial year.

2. Can Profit after tax be less than zero?

If the expenses incurred and taxes are more than the revenue earned then the profit after tax can be less than zero, i.e. negative.

3. Can the terms profit after tax and net income be used synonymously?

Yes, you can use these terms interchangeably. Both of these are arrived at once you have taken out expenses from the revenue.

4. What represents a good PAT percentage?

There is no fixed number which dictates if your PAT is good or not. You should endeavour to get as high a number as you can, but to arrive at meaningful conclusions you should compare PATs from the same sectors.

5. How do taxes affect PAT?

Taxes and PAT have an indirectly proportional relationship. Higher the taxes, lower the PAT, and lower the taxes, higher the PAT.

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