Firstly, this DuPont analysis calculator was created to assist you in comprehending the link between the ROE (return on equity) and its components. Also, the DuPont analysis entails dissecting the ROE and determining what factors influence it. We’ve produced this article to go along with this calculator to explain what DuPont analysis is and how to compute it using the DuPont equation. We’ve also put together several DuPont analysis examples to help you understand the concept.
What is DuPont analysis? – The DuPont Model
The DuPont analysis (also known as the DuPont identity or DuPont model) is a framework for assessing basic performance pioneered by DuPont. DuPont analysis is a strategy for dissecting the many return on equity (ROE) sources. The deconstruction of ROE allows investors to focus on particular important financial parameters to find strengths and problems. It helps you break down a company’s return on equity (ROE) into a number of useful financial measurements to better understand its fundamental capabilities. The following are some of the ratios:
- Financial leverage,
- net profit margin,
- and total asset turnover
Using the DuPont analysis formula, you may split a company’s ROE into three components: profitability, operational efficiency, and financial leverage. This enables you to comprehend how the corporation creates value for its shareholders.
Dupont formula: How to interpret the DuPont analysis calculation?
Now that we’ve established what DuPont analysis and the DuPont framework are, we can discuss how to understand the DuPont model.
DuPont Analysis = Net Profit Margin x AT x EM
The analytical computation used by DuPont is one of the most effective methods for determining and analyzing the company’s competitiveness in the industry. Using DuPont analysis, you may split down ROE into the net profit margin, total asset turnover, and financial leverage. It allows you to look at three different scenarios:
- According to the DuPont model, if a large net profit margin drives the ROE, the return is mostly driven by profitability.
- The company’s ROE is fueled by high total asset turnover. It’s a sign of excellent operational efficiency. As a result, the corporation is able to save even more money.
- If excessive financial leverage is driving the ROE, the firm is gaining a greater return on equity by taking on more debt and risk. According to the DuPont framework, a high ROE fueled by substantial financial leverage may not be sustainable.
What DuPont Analysis Tells You
The components of a company’s return on equity are evaluated using a DuPont analysis (ROE). This enables an investor to see which financial activities are primarily responsible for changes in ROE. An investor may use this type of study to evaluate the operational efficiency of two similar companies. In addition, managers may use DuPont analysis to discover strengths and flaws that need to be addressed.
Operating efficiency, asset usage efficiency, and financial leverage are the three key financial indicators that determine the return on equity (ROE). Net profit margin, or net income divided by total sales or revenue, is a measure of operating efficiency. The asset turnover ratio is a metric for measuring asset efficiency. Finally, the equity multiplier, which is equal to average assets divided by average equity, is used to calculate leverage.
DuPont Analysis vs. ROE
Net income divided by shareholders‘ equity is the return on equity (ROE) statistic. The Dupont analysis is simply an enlarged version of the ROE. The return on equity (ROE) calculation alone reflects how successfully a corporation manages shareholder capital. Investors and analysts may use a Dupont analysis to learn more about what causes changes in ROE and why an ROE is regarded as high or low. For example, a Dupont analysis may assist in determining if ROE is driven by profitability, asset utilization, or debt.
What Are Some Limitations of Using DuPont analysis?
The fundamental flaw in the DuPont analysis is that, despite its breadth, it still depends on accounting calculations and manipulable data. Furthermore, despite its thoroughness, the Dupont study lacks context for why the specific ratios are high or low, or even whether they should be deemed high or low at all.
While the DuPont analysis model may be a valuable tool for investors, it does have several flaws. Because the DuPont analysis is so broad, it needs multiple inputs. As with any computation, the correctness of the inputs determines the outcome. Data from a company’s income statement and balance sheet is used in DuPont analysis, some of which may not be completely correct. Even if the data utilized in the computations are accurate, there are still other issues to consider, such as identifying the relative values of ratios as excellent or poor in comparison to industry norms. Financial ratios are always best examined in comparison, demonstrating how well a firm performs in contrast to its closest business counterparts or in comparison to its own previous performance.
Components of DuPont Analysis: 3-Step DuPont Analysis
The equation for a 3-step DuPont analysis asserts that multiplying a company’s net profit margin, asset turnover, and financial leverage yields the company’s return on equity (ROE). The ROE is split down into three components as the simplified form of the two approaches:
- Net Profit Margin = Net Income ÷ Revenue
- Asset Turnover = Revenue ÷ Average Total Assets
- Financial Leverage Ratio = Average Total Assets ÷ Average Shareholders’ Equity
The ROE formula is the starting point for these three components.
Return on Equity (ROE) = Net Income ÷ Average Shareholders’ Equity
Because the numerator and denominator in both ratios are the same, multiplying the ROE calculation above by two ratios – (Revenue / Revenue) and (Average Total Assets / Average Total Assets) – effectively multiplies ROE by one.
However, by rearranging the phrases, three conventional measurements emerge net profit margin, asset turnover ratio, and leverage ratio. The most often used equation is the DuPont formula, which is presented below:
DuPont = (Net income / Revenue) x (Revenue / Total Assets) x (Total Assets / Shareholder’s Equity)
The ROE variations and what drives the net gain can be better understood by breaking down the ROE calculation into these three components (or decrease). According to the DuPont study, a company’s ROE may be increased if it:
- increases its financial leverage,
- generating a higher net profit margin,
- They are efficiently utilizing assets to generate more revenue.
Dupont analysis of Reliance Industries Example
- Esso (Thailand) Public Company Limited
- Oil Refineries Ltd.
- Tullow Oil plc
- Aemetis, Inc.
- Royal Dutch Shell plc
|Return On Equity|
|Latest Twelve Months||26%||8%||-98%||40%||3%||8%|
|Fiscal Year – 1||-13%||7%||-87%||27%||8%||10%|
|Fiscal Year – 2||8%||15%||3%||35%||12%||12%|
|Fiscal Year – 3||30%||23%||-7%||47%||7%||13%|
|Fiscal Year – 4||39%||17%||-22%||37%||3%||12%|
|Fiscal year – 5||13%||29%||-29%||142%||1%||13%|
DuPont analysis assists a firm in understanding its strong characteristics and analyze the reasons for its growth to maintain a healthy performance. It also aids in the identification of poor performance indicators, allowing the organization to better understand and improve them.
DuPont analysis is a strategy for dissecting the many return on equity (ROE) sources. For example, an investor may use this type of study to evaluate the operational efficiency of two similar companies. In addition, managers may use DuPont analysis to discover strengths and flaws that need to be addressed.
The Income Statement contains numbers for Net Income and Sales. In general, a larger ratio is preferable. However, it is important to highlight that, in order to increase sales, management may cut net profit by lowering pricing.
The fundamental DuPont Analysis approach divides the original ROE calculation into three components: operational efficiency, asset efficiency, and leverage. Net Profit Margin, which reflects the amount of net income made per dollar of sales, is a measure of operating efficiency.