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Du Pont Analysis

DuPont analysis is a method for analyzing a company's return on equity (ROE) by breaking it down into three components: net profit margin, asset turnover, and financial leverage. It was created by DuPont Corporation in the 1920s. The DuPont formula calculates ROE as the product of these three factors, allowing analysts to determine the drivers of ROE and identify areas for improvement.

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566 views5 pages

Du Pont Analysis

DuPont analysis is a method for analyzing a company's return on equity (ROE) by breaking it down into three components: net profit margin, asset turnover, and financial leverage. It was created by DuPont Corporation in the 1920s. The DuPont formula calculates ROE as the product of these three factors, allowing analysts to determine the drivers of ROE and identify areas for improvement.

Uploaded by

Bindal Heena
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Du Pont Analysis

Definition
DuPont formula (also known as the DuPont analysis, DuPont Model, DuPont equation or
the DuPont method) is a method for assessing a company's return on equity (ROE) breaking its
into three parts. The name comes from the DuPont Corporation that started using this formula in
the 1920s.
Calculation (formula)
ROE (DuPont formula) = (Net profit / Revenue) * (Revenue / Total assets) * (Total assets /
Equity) = Net profit margin * Asset Turnover * Financial leverage
DuPont model tells that ROE is affected by three things:
Operating efficiency, which is measured by net profit margin;
Asset use efficiency, which is measured by total asset turnover;
Financial leverage, which is measured by the equity multiplier;
If ROE is unsatisfactory, the DuPont analysis helps locate the part of the business that is
underperforming.


DuPont Analysis
DuPont analysis is an extended analysis of a company's return on equity.
It concludes that a company can earn a high return on equity if:
1. It earns a high net profit margin;
2. It uses its assets effectively to generate more sales; and/or
3. It has a high financial leverage
Formula
According to DuPont analysis:
Return on Equity = Net Profit Margin Asset Turnover Financial
Leverage
Return on Equity =
Net Income

Sales

Total Assets
Sales Total Assets Total Equity
Analysis
DuPont equation provides a broader picture of the return the company is
earning on its equity. It tells where a company's strength lies and where
there is a room for improvement.
DuPont equation could be further extended by breaking up net profit
margin into EBIT margin, tax burden and interest burden. This five-factor
analysis provides an even deeper insight.
ROE = EBIT Margin Interest Burden Tax Burden Asset Turnover
Financial Leverage
Return on Equity
=
EBIT

EBT

Net
Income

Sales

Total
Assets
Sales EBIT EBT
Total
Assets
Total
Equity
Example: Three-factor Analysis
Company A and B operate in the same market and are of the same size.
Both earn a return of 15% on equity. The following table shows their
respective net profit margin, asset turnover and financial leverage.

Company A Company B
Net Profit Margin 10% 10%
Asset Turnover 1 1.5
Financial Leverage 1.5 1
Although both the companies have a return on equity of 15% their
underlying strengths and weaknesses are quite opposite. Company B is
better than company A in using its assets to generate revenues but it is
unable to capitalize this advantage into higher return on equity due to its
lower financial leverage. Company A can improve by using its total assets
more effectively in generating sales and company B can improve by
raising some debt.

DuPont analysis examines the return on equity (ROE) analyzing profit margin,
total asset turnover, and financial leverage. It was created by the
DuPont Corporation in the 1920s.
How it works/Example:
The DuPont analysis is also referred to as the DuPont identity.
In a DuPont analysis, the formula for ROE is:
ROE = Profit Margin x Total Asset Turnover x Leverage Factor
The formula breaks down further to:
ROE = (Net Income/Revenues) x (Revenues/Total Assets) x (Total Assets/
Shareholders'Equity)
For example, let's consider the following information for Company XYZ:

Using the formula above, we can calculate that Company XYZ's ROE is:
ROE = ($2,000/$10,000) x ($10,000/$25,000) x ($25,000/$5,000) = 0.20 x 0.40 x 5
= 0.40 or 40%
The DuPont analysis analyzes the numbers shown in profit margin ($2,000/$10,000),
total asset turnover ($10,000/$25,000) and leverage factor ($25,000/$5,000) to find
Company XYZ's ROE.
Why it Matters:
The DuPont Analysis is important determines what is driving a company's
ROE; Profit margin shows the operating efficiency, asset turnover shows the asset
use efficiency, and leverage factor shows how much leverage is being used.
The method goes beyond profit margin to understand how efficiently a company's
assets generatesales or cash and how well a company uses debt to produce
incremental returns.
Using these three factors, a DuPont analysis allows analysts to dissect a company,
efficiently determine where the company is weak and strong and quickly know what
areas of the business to look at (i.e.,inventory management, debt structure, margins)
for more answers. The measure is still broad, however, and is not a substitute for
detailed analysis.
The DuPont analysis looks uses both the income statement as well as the balance
sheet to perform the examination. As a result, major asset purchases, acquisitions,
or other significant changes can distort the ROE calculation. Many analysts use
average assets and shareholders' equity to mitigate this distortion, although that
approach assumes the balance sheet changes occurred steadily over the course of
the year, which may not be accurate either.

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