The Du Pont Analysis, also known as the Du Pont Identity or Dupont Analysis, is a representation that splits Return On Equity (ROE) into three segments:
Financial Leverage (calculated using an equity multiplier)
Asset use efficiency (calculated using asset turnover)
Operating efficiency (calculated using the profit margin)
Return On Equity or ROE is calculated with the help of the following formula:
ROE = (Net profit/Sales) × (Sales/Assets) × (Assets/Equity)
= (Profit margin) × (Asset turnover) × (Equity multiplier)
This assessment permits the financial analyst to comprehend where greater or lower return is coming from in relation to other firms in similar industries.
The Du Pont Analysis is not useful in some industries, including the banking sector.
The Du Pont Analysis is dependent on the accounting identity, which is a formula or statement true by definition. It is utilized in the following types of industries:
High margin industries
High turnover industries
High leverage industries
The Return On Investment Ratio has been formulated by the Du Pont Analysis for its own purpose. Presently, it is applied by a large number of firms for assessing the efficiency of the usage of assets. It calculates the consolidated results of asset turnover and profit margins.
It is expressed with the help of the following formula:
ROI = Net Income/Sales * Sales/Total Assets = Net Income/Total Assets
The ROE or Return On Equity Ratio is a calculation of the rate of yield to shareholders. Breaking down the ROE into different elements affecting the performance of a company is frequently termed as the Du Pont System.
It is represented with the help of the following formula:
ROE = Net Profit/Equity = Net Profit/Profit Before Tax * Profit Before Tax/EBIT * EBIT/Sales * Sales/Assets * Assets/Equity
Here, net profit is net profit after taxes Equity refers to shareholder’s equity EBIT is Earnings Before Interest and Taxes.
The breakup represents different types of ratios applied in fundamental analysis:
The interest burden of the company is (Pretax profit / EBIT). This should be 1.00 for a company with no financial leverage or debt.
The tax burden of the company is (Net profit / Pretax profit). This is the percentage of the profits of the company held back after the payment of income taxes.
The asset turnover or ATO of the company is (Sales / Assets).
The return on sales or ROS or operating profit margin of the company is (EBIT / Sales). This is the operating profit/dollar of sales.
The return on assets or ROA of the company is (Return on sales * Asset turnover).
The leverage ratio of the company is (Assets / Equity), equivalent to the company’s debt to equity ratio + 1. This is a calculation method of financial leverage.
The compound leverage factor of the company is (Interest burden * Leverage).
ROE may also be expressed as the following:
ROE = Tax burden * Interest burden * Margin * Turnover * Leverage
or ROE = Tax burden * ROA * Compound leverage factor . Here the profit margin is Net Profit/Sales.
Thus the equation of ROE may be reiterated as the following:
ROE = (Net Profit/Sales) * (Sales/Assets) * (Assets/Equity)
Last Updated on : 27th June 2013