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CHAPTER 1 - Financial Statements

CHAPTER 2 - Financial Ratio Analysis

CHAPTER 3 - Time Value of Money

CHAPTER 4 - Bond Valuation

CHAPTER 5 - Cost-Volume-Profit (CVP) Analysis

CHAPTER 6 - Risk and Returns

CHAPTER 7 - Cost of Capital

CHAPTER 8 - Capital Budgeting

CHAPTER 9 - Capital Structure

CHAPTER 10 - Working Capital Management

CHAPTER 11 - Dividend Policy

APPENDIX A - Calculators

Home → CHAPTER 2 - Financial Ratio Analysis

DuPont Analysis
By Yuriy Smirnov Ph.D.

Definition
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3/27/2019 DuPont Analysis | Definition | Formula | Model | Example | Interpretation | Chart | Advantages and Disadvantages | Calculator

DuPont analysis is a model widely used in financial ratio analysis to designate the ability of a company to increase
its return on equity ratio (ROE). The model breaks down ROE ratio into three components: profit margin, asset
turnover, and financial leverage.

Formula
The DuPont model is expressed as follows:

ROE = Profit margin × Asset Turnover × Financial Leverage

or

Net Income Net Sales Total Assets

ROE = × ×
Net Sales Total Assets Total Shareholders’ Equity

Profit margin, also known as net profit margin, is usually calculated for common shareholders; thus, net income less
preferred dividends (if available) should be used.

Average total assets are the sum of total assets at the beginning and at the end of the period divided by 2.

Value of total assets and shareholders’ equity can be found in the balance sheet, net sales and net income can be
found in the income statement, and preferred dividends can be found in the notes to the financial statements.

DuPont model interpretation

DuPont analysis breaks down return on equity into three major components to determine the impact of each of
them.

i. Profit margin. This ratio reflects a company’s strength in generating profit from each dollar of sales.

ii. Asset turnover. This ratio measures how efficiently a company uses its assets to generate sales.

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iii. Financial leverage or equity multiplier. This ratio shows the extent to which a company uses debt financing.
The greater the value of a ratio, the greater the risk and uncertainly of expected ROE.

The goal of DuPont analysis isn’t to calculate ROE but to identify factors affecting it. If investors are not satisfied with
the current ROE ratio, management can analyze what problems caused its current value and attempt to solve them.

Example

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The balance sheet of XYZ company is as follows:

Balance sheet, US$ in thousands

The reported statement of income for the 20X8 financial year is as follows:

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XYZ company has declared total preferred dividends of $250,000.

To find net income attributable to common shareholders, we needed to subtract the total amount of preferred
dividends of $250,000.

$5,350,000 - $250,000
Profit Margin = × 100% = 11.16%
$45,680,000
The average total assets are $54,420,000 ([$52,970,000 + $55,870,000] ÷ 2); thus, asset turnover ratio is as follows:
$45,680,000
Asset Turnover = = 0.84
$54,420,000
The total common shareholders’ equity at the end of the current year is $31,740,000 ($33,740,000 - $2,000,000)
and $34,060,000 ($36,060,000 - $2,000,000) at the beginning of the year. Thus, the average common shareholders’
equity is $32,900,000 ([$31,740,000 + $34,060,000] ÷ 2).

$54,420,000
Asset Turnover = = 1.65
$32,900,000
In terms of the DuPont model, the ROE of XYZ company is 15.47%.

ROE = 11.16% × 0.84 × 1.65 = 15.47%

Let’s assume another company of the same size operating in the same industry having a profit margin ratio of
11.23%, an asset turnover ratio of 1.19, and financial leverage of 1.16. It has the same ROE of 15.47%.

ROE = 11.23% × 1.19 × 1.16 = 15.47%

Although both companies have about the same profit margin, DuPont analysis shows they have different strengths
and weaknesses in assets turnover and financial leverage. XYZ company can increase its ROE by improving assets
utilization, and the other company can increase its financial leverage ratio.

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DuPont chart
The DuPont model can be more complicated than the 3-factor model mentioned above. For example, more detailed
analysis can be done using the 5-factor model.

EBIT EBT Net Income Net Sales Total Assets

ROE = × × × ×
Net Sales EBIT EBT Total Assets Total Shareholders’ Equity

where EBIT is earnings before interest and tax, and EBT is earnings before tax.

For deeper insight, the 5-factor DuPont model additionally breaks down profit margin into three components to
determine the impact of interest and the tax burden.

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An example of deeper decomposition of ROE is shown in the DuPont chart below.

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Advantages and disadvantages of DuPont analysis

Advantages
DuPont analysis is an excellent technique to determine the strengths and weaknesses of a company. Each weak
financial ratio used in the model can be decomposed to get deeper insight into the source of weakness. When
sources of weakness are identified, management can take some actions (e.g., improve expense control, asset
management, or marketing) to improve the return on equity ratio.

Disadvantages

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The main drawback of DuPont analysis is that it uses accounting data disclosed in financial statements, which can
be manipulated by management to hide some weaknesses. Thus, to get correct results, accurate accounting data
must be inputted.

Another disadvantage is inherent to all financial ratio analysis systems. It works best to compare companies of the
same size working in the same industry.

Calculator
You can carry out the DuPont analysis using our online calculator.

← Equity Multiplier Ratio Asset Turnover Ratio →

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