Home For AAT student members AQ 2013 AAT Level 4 (Level 8 in Scotland)
Current updates regarding coronavirus (Covid-19) and the precautions AAT are taking will be continually updated on the below page.

Please check this link for the latest updates:
We hope you are all safe and well and if you need us we will be here. 💚


Is Net Profit % Calculated Before or After Taxation?

I am doing CMCC/Unit 15 at the moment and have come across something I am getting a bit confused about - net profit %. In the past I have always had to compare net profit % & gross profit % but have never really had to consider taxation in the units I've studied - I've only just worked out what operating profit is, which was another new one on me.

Does net profit % use net profit before taxation or afterwards? I understand that operating profit % is calculated using profit before interest or taxation. But is net profit % based on profit after interest but before taxation or after interest and taxation?

Thanks for your help.

CelticStar :001_smile:

Comments

  • SandyHoodSandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    CelticStar

    In CMCC you are studying how well management use the resources at their disposal. You will no doubt attract replies from forumites who want to tell you about the shareholder ratios where the objectives and measures are different.

    When you measure operational performance in prospective credit customers you should look at their ability to produce profits from their operations. In other words you should ignore financing costs and tax in the % return management are producing.
    Financing can be looked at using another ratio such as the interest cover or gearing.

    I hope this is clear.
    Sandy
    [email protected]
    www.sandyhood.com
  • CelticStarCelticStar Well-Known MAAT Posts: 142
    Thank you for your reply, Sandy, but I am still a little confused so wonder if you could just clarify things for me a little more.

    In my textbook (Osborne) I am given the following ratios to measure profitability:

    ROCE
    Operating Profit % (which is described as profit before tax and interest are deducted) &
    Net Profit Ratio % (which is described as profit after the deduction of all expenses)


    The second paragraph in your post seems to be explaining operating profit % and makes perfect sense to me. But what about net profit %? Is the profit figure used here the profit after interest but before tax or is it after interest and tax have been deducted?

    Thank you for your help, I really appreciate it.
    CS
  • SandyHoodSandyHood Font Of All Knowledge Registered, Moderator Posts: 2,034
    I think the problem is in the expression net profit.
    It is not something that appears in financial reporting standards for incorporated businesses.
    We tend to use it for unincorporated businesses to describe how much the owners have made.
    So when you try to look at the two together the word operating and the word net tends to make you think they are different.

    My advice is to treat both as meaning the same thing.

    When I first started to teach ratios I used to say how important it is to choose a good way to lay out the answer.
    I still do. There are several different definitions of very many ratios. I have recently read a very well respected american management accounting book that refers to net profit as the income available to share holders after tax and after all financing cost. Other forumites will no doubt have their favourites.

    I go back to my initial point, what are we measuring?

    And as we are looking at the ability of management to produce profits then I would be looking at those profits before interest and before tax.
    I would look at the level of indebtedness using a gearing ratio, so any reduction of the profit due to interest charges would confuse my picture of the ability of the managers to generate profit from operations with the financial structure question.

    Finally, make it clear to the marker how you have defined the ratios you use
    I recommend this sort of column based approach

    Name of Ratio.....Formula in words..........Year and calculation.....Ratio.....Year and calculation.....Ratio
    ...................................................................2006.......................................2007
    Net profit%......... Operating Profit x 100............£35,000 x 100..........17.5%.........£42,000 x 100............15%
    ..........................Sales Revenue.....................£200,000..................................£280,000
    Sandy
    [email protected]
    www.sandyhood.com
  • CelticStarCelticStar Well-Known MAAT Posts: 142
    Thank you very much for taking the time to help me, Sandy. I feel I understand it a lot better now. You can guarantee that I will always be saying in the back of my mind: "What am I measuring?" when looking at ratios now! :001_smile:
Sign In or Register to comment.