Definition of Profit after tax
Profit after tax refers to the net earnings of the company available for the distribution to the shareholders or the owners after the deduction of all the expenses including operating as well as non-operating expenses, interest costs, and the current year taxes from the total business income or we can say after deducting of tax expenses from the profit of the business before tax (PBT), we get the figure of Profit after tax (PAT).
Explanation
Taxes refer to the amount of money paid by the business entities on the net income earned by them. When the company deducts non-operating, operating and interest expenses from the sum of operating income, interest income& other income of the business then the figure that arrives is known as profit before taxes (PBT). Now to calculate the Profit after tax (PAT), tax expense is deducted from the profit before taxes (PBT). The figure of PAT is considered to be the best measure to analyze the ability of the business to generate profits.
Formula for profit after tax
The formula for PAT is:
PAT = Profit Before Tax * (1- Tax Rate)
Where Profit before tax is the earnings of the company after deducting all the expenses including interest expense from the total revenue of the company (operating & non-operating both) And tax rate is the prevailing income tax rates in the country as per the income tax authorities.
How to Calculate Profit After Tax?
The PAT is calculated by deducting the amount of income taxes from the profit before taxes of the business.
Step by step calculation of computation of PAT:
- Step 1: Calculation of Profit before taxes: PAT is the figure on which the income tax rate is applied so basically the PAT is the taxable amount. Profit before taxes is calculated by deducting operating expenses & non-operating expenses from the sum of total operating & non-operating income.
- Step 2: Determining tax percentage and Calculation of Tax amount: For this percentage of tax applicable to the company as per the income tax authorities is to be determined. After that when we apply the percentage of the tax rate on the taxable amount i.e. on profit after-tax amount, we get the figure of tax. In case of losses the tax is not applicable; as the taxes are to be paid in case the company earns the profits, therefore in such a case losses after tax and the losses before tax are the same.
- Step 3: Calculation of PAT: Now in the third step, the tax amount calculated in step 2 is deducted from the amount of profit before taxes calculated in step 1 in order to derive the PAT earned by the company during the period.
Example of Profit After Tax
Suppose there is a company named ABC Inc. whose total turnover during the previous financial year was $20,000. Following are the additional details:
- Interest income earned on fixed deposits: $2,000.
- The total operating expenses: $5,000
- Interest on loan: $1,000.
The tax rate of the company is 30%. Calculate the PAT.
Solution:
Calculation of Profit after tax
| Particulars | Amount ($) |
| Turnover | 20,000 |
| Add: Interest Income | 2,000 |
| Total Income [A] | 22,000 |
| Operating Expenses | 5,000 |
| Interest Income | 1,000 |
| Total Expenses [B] | 6,000 |
| Profit before tax [A-B] [C] | 16,000 |
| Tax Rate @30 % [D] | 4,800 |
| PAT [C-D] | 11,200 |
Therefore, PAT of the company during the previous financial year was $11,200. This profit after tax is generally available for distribution to the shareholders of the company.
Profit After Tax in Balance Sheet
When the profits are made by the company during any period, then each year these profits are stimulated from the company’s statement of profit and loss into its balance sheet. In the balance sheet, it is reflected as retained earnings in the head “Reserve and Surplus” under the equity section. Thus, the amount of PAT is reported in the company’s balance sheet as retained earnings for the period.
Advantages
The advantages of PAT are as follows:
- The amount of PAT helps to know the profitability position of the business after paying off all the expenses including tax expenses.
- The higher the amount of PAT, the higher the efficiency of the business to earn profits and a lower amount of PAT indicates low or average profit-earning efficiency of the business.
- The amount of PAT determines the earnings available for the shareholders to be distributed as dividends. The higher the profit, the higher is the dividend yield.
- The share price of the business also fluctuates according to the PAT. A higher amount of PAT results in a high stock price.
- Higher PATof the company fetches more number of investors as the company earning higher profits after taxes can be easily relied upon by the investors in terms of returns that can be earned from the amount invested.
Disadvantages
Disadvantages of PAT are as follows:
- The concept of PAT is not applicable in the case of a company’s losses which means business is not sustainable in case of continuous losses.
- When the tax rates are higher than it shows that the income tax burdens are more and the earnings available for the shareholders are very less.
- At the times of inflation when the operating expenses are higher, PAT gets reduced or may become negative leaving the earnings available for the equity shareholders at zero.
Conclusion
Thus, PAT is the amount of profit that is earned by the business after deducting all the expenses (operating as well as non-operating) and the current year taxes as applicable. It is calculated by deducting tax expense from the Profit before taxes. The higher the PAT of the company, the higher the efficiency of the company to earn profits.
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