Dupont Analysis

The DuPont analysis is a method of using financial ratios to assess the financial performance of a business.

The original DuPont analysis was used to analyse return on assets (ROA) into component parts.

ROA = Net income / Assets
ROA = (Net income / Revenue) x (Revenue / Assets)
ROA = Profit margin x Asset turnover

This original DuPont analysis formula showed that the return on assets is a function of the profitability of the business represented by the profit margin ratio, and the operational efficiency of the business represented by the asset turnover ratio.

This formula however does not show the effect of the financial leverage (the amount of debt) within the business, and so the DuPont analysis was extended to analyse the return on equity (ROE)

ROE = Net income / Equity
ROE = (Net income / Revenue) x (Revenue / Assets) x (Assets / Equity)
ROE = Net profit margin x Asset turnover x Equity multiplier
or alternatively
ROE = ROA x Equity multiplier

This extended DuPont analysis shows that the return on equity to an investor is a function of the profitability (indicated by the net profit margin ratio), the operational efficiency represented by the asset turnover ratio, and the financial leverage represented by the ratio of assets to equity, and known as the equity multiplier.

Using the DuPont analysis, an investor can see which elements of the business contribute to their total return on equity by looking at:

  1. How efficiently sales are being used to generate profits (net profit margin)
  2. How well assets are being used to generate revenue (Asset turnover)
  3. How much the business is using financial leverage (Equity multiplier)

DuPont Analysis Example

As an example of DuPont analysis, suppose the accounts of two businesses show the following financial information:

Information from Accounts
Business A Business B
Net income 30,000 63,000
Revenue 350,000 600,000
Assets 300,000 630,000
Equity 100,000 210,000

Using the DuPont analysis we can calculate the return on equity for both of these businesses as follows:

Dupont Financial Analysis Model
Business A Business B
Net profit margin 9% 11%
Asset Turnover 3.50 0.95
Equity multiplier 1.0 3.0
Return on equity (ROE) 30% 30%

Both businesses have the same return on equity for investors, however, the DuPont analysis shows that despite having similar profitability, business A has no leverage and gets its return from efficient use of its assets shown by the higher asset turnover ratio, whereas business B generates the investor return using financial leverage shown by the higher equity multiplier.

A further extension of the first term of the DuPont analysis produces the five ratio formula

ROE = (Net income / Revenue) x (Revenue / Assets) x (Assets / Equity)
ROE = (Operating income / Revenue) x (Revenue / Assets) x (Income before tax / Operating income) x (Assets / Equity) x (Net income / Income before tax)
ROE = Operating margin x Asset turnover x Financial cost ratio x Equity multiplier x Tax effect ratio 

The first two terms, operating margin and asset turnover represent the operational aspects of the business, how much profit can be obtained from revenue, how well assets are managed. The next two terms, financial cost ratio, and equity multiplier show how the return on equity is effected by the capital structure and finance costs of the business. And finally the tax effect ratio shows the impact of taxation on the return on equity.

DuPont Analysis Summary

The formulas developed on this page are summarized for easy reference in the diagram below.

dupont analysis v 1.0
DuPont Analysis Summary Preview

The DuPont analysis summary is available for download in PDF format by following the link below.

Dupont Analysis November 6th, 2016Team

You May Also Like

Related pages

formula for debtors collection periodimplicit interest ratechart of accounts for merchandising businessreceived invoice journal entryaccounting ledger bookreceivable control account formatpmt on excelafda accountingpv pmtlifo vs fifo accountingdefine freight collectbills receivable and bills payable meaninggearing ratio calculationwhen a partnership is liquidatedpresent value of lease payments calculatormirr in excelwhat are manufacturing overheadspmt calculationcalculate markup percentjournal voucher entriesbond premium calculatorprintable blank spreadsheet templatesmanufacturing overhead variance analysisannuity perpetuityannuities formulasprepayment double entrynon profit financial statement template freeunits of output depreciation calculatortwo column cash bookthe rule of 78 calculatorannuity on excelprepaid insurance journal entrycash suspense account definitionexcel paybackpresent value coupon bondpayback method definitionmileage form templatespresent value of annuity calculationaccrual accounting vs cashhow to do unadjusted trial balancedebts and creditsaccounts payable ledger templatesingle step income statement formathow to calculate depreciation using straight line methodcontra income accountdupont analysis calculatoramortised cost calculationaccounting for vacation accrualjournal entry for deferred revenueexcel formulas for accounting pdfaccounting stockholders equityfutures accounting entriesannual equivalent rate calculatorposting from journal to ledgerdefine transactional analysisbalance sheet from trial balance examplestvm tablespresent value of an annuity excelexample of cash disbursement journalfactoring accountingdefine accrued interestaccounts payable salary ukadjusting entries always includeconvertible note accounting treatmentexpense template for small businessexpanded accounting equation calculatorformula for owners equityconverting preferred stock to common stockage of accounts receivable formulaperpetual inventory using fiforeorder point and safety stockwhat is markup and marginpurchased intangible assetssample chart of accounts for manufacturing companyreconcile accounts payablechart of accounts restaurant examplegross profit cogsprovision for losses on accounts receivable