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# Department of Management Sciences

## Supply Chain Management

Assignment # 2 (BBA 5-D)

01-111162-109

## 14th February, 2019

What is the DuPont Analysis?

DuPont analysis is a financial ratio analysis method linking together information from
two of the three main financial statements: the income statement or profit and loss
statement, and the balance sheet.
The Return on Equity financial ratio (Net Income divided by Equity) becomes more
meaningful when you dive into its drivers using DuPont analysis.
Here’s the 3-part version of the DuPont analysis. The first element, ROS or Return on
Sales, is Net Income divided by Sales, which is an indicator of the relative profitability or
operating efficiency. The second element is Asset Turnover, calculated as Sales divided
by Assets, a measure of asset use efficiency. The last element of the DuPont 3-part
equation is leverage, Assets divided by Equity.

Example: Assume you want to start a small business. Let’s say a juice shop!
You figured out that the business requires initial funding Rs. 100,000.
So you invested Rs. 40,000 from your pocket and borrowed Rs. 10,000 from one of
your friends. The balance amount was funded by a bank.
After a year your business did well and you earned a profit Rs. 10,000.
If you calculate the returns on your own investment (i.e. Rs. 40,000) it will be 25%
(10000/40000).

However you are not quite happy with the returns and wanted to have an analysis of
how you could increase the returns on your own funds.

After the analysis you come up with three possible solutions to increase returns on

 You can increase the selling price per cup of juice so that it will generate
more profit (Bottom line growth).
 You can increase the Revenue by reducing the selling price to attract more
customers (Top line growth).
 You can pump in more money through bank loans or from any other sources

## Return on equity = Profit/Equity

Here, Equity is the shareholders’ fund which includes Equity share capital and
Reserves & surplus (Net Worth).
The three possible solutions mentioned above are nothing but the three factors of
DuPont Analysis!

## Now let’s try and understand this formula.

 The first solution is to increase your profitability i.e. increase in the Profit
Margin (Profit/Sales)
 The second solution is to increase your revenue in order to increase the
Assets Turnover Ratio i.e. (Sales/Assets).
 And the last one is to increase the Leverage Ratio
i.e. Assets/Equity (Leverage ratio can be increased either by reducing the
equity share capital or raising funds through long term borrowings such as
Bonds, Bank loan etc).

## The primary advantage of DuPont analysis is the fuller picture of a company's

overall financial health and performance that it provides, compared to more limited
equity valuation tools. The DuPont analysis model provides a more accurate
assessment of the significance of changes in a company's ROE by focusing on the
various means that a company has to increase the ROE figures.

## A main disadvantage of the DuPont model is that it relies heavily on accounting

data from a company's financial statements, some of which can be manipulated by
companies, so they may not be accurate. Also it does not include the cost of capital
(WACC).