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Have you ever thought why a company that’s supposedly doing well lacks cash on hand? Well, the secret often lies in Profit After Tax, or PAT for short. This guide is all about discovering PAT. Whether you’re investing or running the show, it’s a must-know for anyone in the business game.
An overview of profit after tax
PAT simply shows how much net profit a company actually earns. They calculate it by taking total revenues earned minus all costs like materials, salaries, operating expenses, interest payments and taxes. After removing all those expenses, the PAT or net profit is what’s left. Essentially, it tells you how much real profit the business made at the end of the year after paying its dues.
PAT highlights the profitability of a business after excluding all associated costs incurred during the year. It portrays how efficiently the company has generated surplus from its regular business activities.
A high PAT denotes that the company has earned substantial profits, which can be potentially distributed among its shareholders. On the flip side, a declining PAT over successive years indicates deteriorating profitability and calls for corrective actions.
How do you calculate PAT?
- You begin with all the money the company earned by selling its products or services. This is the total revenue or income.
- Then you remove the direct costs of making those products – raw materials, factory worker salaries, packaging materials. Those are costs tied directly to production.
- Next, subtract the operating expenses. These are costs like rent, utilities, staff salaries, office supplies, advertising, etc. – regular business costs.
- Don’t forget to deduct interest paid on business loans or corporate bonds that were taken.
- Finally, take out any taxes the company paid – income tax, sales tax, etc. This is the amount owed to the government.
- After removing all the above costs and taxes, the remainder is the PAT or net profit.
Thus, the PAT formula is:
PAT = Total Revenues – Direct Expenses – Operating Expenses – Interest Costs – Tax Expenses
Let’s understand this with a company example:
ABC Ltd has:
- Total Revenues: ₹50 Crores
- Direct Expenses: ₹25 Crores
- Operating Expenses: ₹10 Crores
- Interest on Loans: ₹3 Crores
- Total Tax Expense: ₹5 Crores
Applying the above formula:
So, when we deduct all its costs and tax payments from the total revenues earned, we get ₹7 Crores profit.
Why should you care about PAT?
Here are some key reasons why PAT holds high significance:
- PAT gives the true picture of the company’s profitability after removing all associated costs and taxes. It highlights the actual surplus generated by the core business.
- The trend in PAT over the years indicates whether the profitability is improving or declining. Rising PAT denotes increasing efficiency.
- Key financial ratios including Return on Equity, Return on Capital Employed, Profit Margin, etc, are calculated using PAT. These ratios evaluate the management’s performance.
- PAT is a key factor investors consider while analysing stocks for investment. A high and consistent PAT signals strong financial health.
- PAT growth enables a company to raise funds from investors more easily. Banks also evaluate PAT before lending loans.
- PAT is the best metric to assess shareholder value creation by a company. Increasing PAT year-on-year leads to higher market value.
- The top management utilises PAT to make decisions like expansion plans, diversifications, capital investments, and other strategic moves.
- Dividend payments to shareholders are made from PAT. Thus, it directly influences shareholder payouts.
- PAT is the most reliable indicator of a business’s profitability and earnings capability. Tracking PAT gives crucial insights into a company’s financial position and health.
What factors impact PAT the most?
Here are some key factors that affect PAT:
- Sales Revenues –Boosting sales volumes, enhancing your product range, and breaking into new markets are major factors that can positively impact Profit After Tax (PAT). When revenues increase, profits often follow suit, leading to a healthier PAT. These steps are crucial for driving growth and improving a company’s financial health.”
- Cost Management – Keeping a tight grip on costs is crucial for boosting Profit After Tax (PAT). By reducing expenses in production, distribution, marketing, and other areas without sacrificing revenue, you can significantly increase PAT.
- Economies of Scale – Whenever a business grows its operations, it benefits from economies of scale. This means it can spread its fixed costs over a larger number of products. As a result, the cost for each unit produced goes down. This efficiency boosts Profit After Tax (PAT), lowering overall costs while maintaining or increasing revenue.”
- Operating Leverage – Some costs like factory rent or equipment leases stay fixed even if a business sells less. So when sales go up, these fixed costs get spread over more units sold. That can rapidly boost the PAT! But it works both ways. If sales fall, the PAT takes a bigger hit as those fixed costs remain the same. So, operating leverage can swing the PAT for companies depending on sales.
- Debt/Equity: If a company relies too much on loans and debt, it has to pay more interest. This cuts into the PAT. But if it’s over-dependent on owners’ money, it can’t grow quickly. The trick is to balance debt and equity well. This way, interest costs are controlled, and PAT is protected. Smart management of capital structure is key to good profits!
- Debt/Equity – The balance between debt and equity in a company’s finances is key to its Profit After Tax (PAT). If a company leans too heavily on borrowed money, the higher interest costs can eat into its PAT. Finding the sweet spot in capital structure is crucial to minimize financing costs and protect profits.”
- Asset Efficiency – Asset efficiency is a big player in boosting Profit After Tax (PAT). When a company uses its assets effectively to ramp up revenues, its PAT often sees a positive impact. This includes better management and turnover of assets like cash and inventory.
How can companies improve their PAT?
For businesses, boosting PAT is a key priority to enhance shareholder value. Here are some smart ways to improve Profit After Tax:
- Drive Revenue – Adopt innovative marketing, increase market share, launch new products, and explore additional channels and markets to drive top-line growth.
- Reduce Costs – Use automation lean processes, optimise the supply chain, and aggregate purchases to reduce operational costs. Rationalise overheads.
- Optimise Taxes – Leverage deductions, allowances and exemptions permitted under tax laws to lower tax liability.
- Restructure Operations – Shift manufacturing to tax-friendly locations. Outsource non-core activities. Consolidate operations to gain economies of scale.
- Financial Restructuring – Retire high-cost debt and refinance at lower interest rates. Optimise working capital to reduce interest costs.
- Enhance Asset Efficiency – Regularly review assets to identify underutilised or obsolete assets and dispose of them. Improve inventory by turning debtor days to unlock working capital.
- Adopt Technology – Leverage the latest technology, like IoT, automation, AI, etc., to control costs and drive productivity.
- Diversify / Innovate – Venture into more profitable products/services and phase out loss-making lines. Continuously innovate to boost revenues.
The PAT metric reveals how good a company is at generating surplus profits from its business operations. It is the most reliable measure of profitability after removing all expenses incurred in earning revenues.
A consistently rising PAT signifies the operational efficiency and financial health of a company. As an investor, focus on companies delivering solid PAT growth year after year. For businesses, boosting PAT should be a key priority and strategic objective.
A positive PAT indicates that the company is making a profit after covering all expenses and taxes.
Yes, if a company’s expenses and taxes exceed its revenue, the PAT can be negative, signaling financial challenges.
Profit After Tax (PAT) is the financial metric that represents the net income a company generates after deducting all applicable taxes from its total revenue.