FINANCIAL MANAGEMENT: DuPont Analysis

In this article, we will go through the dupont analysis which is used to analyze company`s performance. it is useful for commerce and management students.

DuPont ANALYSIS

DuPont Analysis is the most effective system of evaluating company`s performance.this system was developed in U.S.A. in 1920 by DuPont company to examine its financial statements. This system has received widespread recognition and acceptance. The main goal of every management is to maximize return on capital employed. Return on capital employed is therefore the key ratio to analyse the performance of nay business.

What Is the DuPont Analysis?

The DuPont analysis (also known as the DuPont identity or DuPont model) is a framework for analyzing fundamental performance popularized by the DuPont Corporation. DuPont analysis is a useful technique used to decompose the different drivers of return on equity. The decomposition of ROE allows investors to focus on the key metrics of financial performance individually to identify strengths and weaknesses.

There are three major financial metrics that drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage. Operating efficiency is represented by net profit margin or net income divided by total sales or revenue. Asset use efficiency is measured by the asset turnover ratio.leverage is measured by the equity multiplier, which is equal to average assets divided by average equity.

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Formula and Calculation of DuPont Analysis

The DuPont analysis is an expanded return on equity formula, calculated by multiplying the net profit margin by the asset turnover by the equity multiplier.

 

DuPont Analysis=net profit marginATEM

Where

Net profit margin=Net income/revenue

AT=Asset turnover

Asset Turnover=Sales/average total assets

EM=Equity multiplier

Equity multiplier=average total assets/average equity

Use of DuPont analysis for managerial purpose

DuPont analysis is a very useful tool for measuring companys performance and has, therefore,been adopted by many companies in some form or the other. DuPont chart uses the inter relationship of net profit and capital turnover ratios to judge the overall  shareholders performance and earning capacity of the enterprises. This helps management to identify and correlate the various factors that have a bearing on the firms profitability.

DuPont Analysis Component:

There are three basic components of DuPont analysis:

1. Net profit margin
2. Asset turnover ratio
3. Financial leverage

DuPont Analysis vs. ROE

The return on equity (ROE) metric is net income divided by shareholders’ equity. The Dupont analysis is still the ROE, just an expanded version. The ROE calculation alone reveals how well a company utilizes capital from shareholders.

With a Dupont analysis, investors and analysts can dig into what drives changes in ROE, or why an ROE is considered high or low. That is, a Dupont analysis can help deduce whether its profitability, use of assets or debt that’s driving ROE.

Limitations of Using DuPont Analysis

The biggest drawback of the DuPont analysis is that, while expansive, it still relies on accounting equations and data that can be manipulated. Plus, even with its comprehensiveness, the Dupont analysis lacks context as to why the individual ratios are high or low, or even whether they should be considered high or low at all.