NOPAT vs EBITDA: What’s the Difference?

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What’s NOPAT?

Net operating profit after taxes or commonly referred to as NOPAT measures the operating income of a firm that would be attributable to both its shareholders and debtholders after accounting for tax payments. 

The formula for NOPAT goes as follows:

Operating income represents the operational profit of a firm because it accounts for all operational expenses such as COGS, research & development, marketing, and depreciation. You can look up the operating income for any given public company by having a look at its income statement.

The tax rate that is used in computing NOPAT will mostly be the effective tax rate of the business or the marginal tax rate which can be changed throughout time by new tax laws. Since the effective tax rate is lower than the marginal tax rate, a company’s current net operating profit after taxes will likely be understated when using the latter. 


Example

Let’s suppose that company A reported an operating income of $50 million in the last year. If we assume a tax rate of 27%, we would calculate company A’s NOPAT by multiplying $50 million with 0,63 (1-27%) which would give us a net operating profit after taxes of $31,5 million. 


What’s EBITDA?

EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization and measures a company’s operational earnings while excluding interest expenses, tax payments, and depreciation/amortization charges.

While there are multiple ways in computing a firm’s EBITDA, the easiest approach would be to start from EBIT:

The easiest way to compute a firm’s EBITDA is to add back depreciation and amortization back to EBIT because it was subtracted previously to calculate operating income. 


The Difference Between NOPAT and EBITDA

NOPAT represents a company’s operating profit after accounting for taxes while EBITDA starts with the firm’s EBIT and adds back depreciation and amortization. The following table may illustrate the differences in the computation of both metrics.

Revenue

(-) COGS

= Gross Income

(-) Operating Expenses

= Operating Income

(+) Interest Income

= EBIT

(+) Depreciation

(+) Amortization

= EBITDA

Revenue

(-) COGS

= Gross Income

(-) Operating Expenses

= Operating Income

(-) Tax Payments

= NOPAT 

In order to calculate EBITDA, we start at a firm’s EBIT, which is often slightly different from operating income because of the net effect from non-operating income and expenses. We then add back depreciation and amortization (both are non-cash expenses) since the purpose of EBITDA is to reflect a clearer picture of a company’s operational performance. 

NOPAT already has depreciation and amortization expenses subtracted out, and we don’t add them back as they’re part of a company’s operating expenses. We then calculate the firm’s theoretical profit by applying an appropriate tax rate to the operating income. 

As a result, the main differences between NOPAT and EBITDA are that:

  • NOPAT is after taxes whereas EBITDA is prior to tax payments
  • EBITDA includes other non-operating income as well
  • NOPAT accounts for depreciation & amortization charges while EBITDA adds them back

 


Why Do People Use NOPAT?

NOPAT is sometimes preferred over other profitability measures because it properly measures a firm’s income from operations without being screwed by non-operational effects (like investment gains from outside holdings) and leverage. This allows for better comparison between companies with different financing structures.

The metric also plays an important role in valuation and financial modeling because it acts as a starting point for the calculation of free cash flow to the firm (FCFF). In finance, there is a strong emphasis on cash flows instead of earnings since they can mostly differ heavily from each other as a result of adjustments made from accounting practices. 

Free cash flow to the firm represents the actual cash flows that are available to not only the equity holders but also the debt holders of the firm. NOPAT is used to compute FCFF because it measures the operating profit that belongs to both equity and debt claims.  


Why Is EBITDA Used a Performance Metric?

EBITDA is often used by investors, analysts, and even some companies as a more useful measure of a firm’s operational profitability because it excludes any effects caused by capital expenditure decisions (that result in non-cash charges like depreciation and amortization) and financing choices (which are reflected in interest payments).

That being said, the metric also has significant drawbacks that can be exploited by companies to misleadingly present operating performances. 

Many of the firms that rely on EBITDA as a metric to disclose their financial results are unprofitable in the first place. Because a negative bottom line (net income) would not indicate a positive signal to investors, businesses may want to point to their positive EBITDA instead. 

The problem here is that EBITDA can not be used as a substitute for cash flows primarily because it doesn’t account for changes in working capital and capital expenditures (both are cash outflows which are crucial for the operations and long-term success of a company). 


Conclusion

Both NOPAT and EBITDA are financial metrics that measure a firm’s profits in different stages within the income statement. NOPAT represents a company’s operating income after taxes and doesn’t account for interest expenses. EBITDA, on the other hand, reflects a firm’s earnings before interest as well but further adds back non-cash charges like depreciation and amortization. To conclude, NOPAT and EBITDA are certainly distinguishable from each other as each metric is used for different purposes.  

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