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What is DuPont Analysis?
The DuPont analysis is a financial method used for evaluating the component parts of a company return on equity (ROE). DuPont analysis can also be defined as a framework for analyzing fundamental performance of a firm. Investors use it to determine what financial activities influences the ROE. The ROE allows investors to identify firm strengths and weaknesses. DuPont developed in 1920s by the DuPont Corporation to assess the company’s profitability. The DuPont Analysis model breaks down the firm ROE into parts; financial leverage, asset use efficiency and operating efficiency.
The DuPont analysis model takes into considerations three financial metrics;
Operating efficiency- The operating efficiency is represented by the net profit margin or net income divided by total sales.
Leverage- The leverage is measured by the average asset or the equity multiplier divided by average equity.
Asset use efficiency- The asset use efficiency is measured by the turnover ratio
DuPont Analysis Formula
The DuPont analysis formula is used to determine the company return on equity. It is calculated by multiplying the asset turnover by the net profit margin by the equity multiplier. The formulas can be expressed as;
DuPont Analysis =Net profit Margin x AT x EM
Where AT is the Asset Turnover and EM is the Equity multiplier
The net profit margin is calculated by the formula;
Net profit Margin = Net Income/ Revenue
AT = Sales / Average Total Assets
EM= Average Total Assets/ Average Shareholders’ Equity
What is DuPont Analysis Tell you?
The DuPont analysis was mainly used to evaluate the components of a firm’s return on equity (ROE). It allows the investor to establish what financial activities in the company affects its ROE. The framework can also be used to compare operational efficiencies of two companies before investing. Additionally, managers can also use DuPont analysis method to identify the strengths and weaknesses of the company should address.
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