Khawaja Sameer

L1F17BSAF0046

Submitted to Sir Abid Noor

When are DuPont analysis? Why they are needed. Explain the utility of DuPont analysis
from various stakeholders’ viewpoint

DuPont Analysis

A type of analysis that examines a company's Return on Equity (ROE) by breaking it into
three main components: profit margin, asset turnover and leverage factor. By breaking the
ROE into distinct parts, investors can examine how effectively a company is using equity,
since poorly performing components will drag down the overall figure. To calculate a
firm's ROE through Du Pont analysis, multiply the profit margin (net income divided by
sales), asset turnover (sales divided by assets) and leverage factor (total assets divided by
shareholders' equity) together. If higher result, the higher the return on equity.

There are three major financial metrics that drive return on equity (ROE).Operating efficiency is
represented by net profit margin or net income divided by total sales or revenue. Asset use
efficiency is measured by the asset turnover ratio. Leverage is measured by the equity multiplier,
which is equal to average assets divided by average equity.

1. Profitability (measured by net profit margin)

2. Asset efficiency (measured by asset turnover)

3. Financial leverage (measured by equity multiplier)

Formula of DuPont Analysis

Basic Du Pont

Return on investment =return on assets =Earning power

ROI=ROA=Earning power

ROI=net profit margin x Total asset turnover

= (Net profit after taxes / net sales*100) x (Net sale /Total assets)

= (Net profit after taxes/total assets) *100

This ratio tells us the earning power on shareholders book value investment and is frequently
used in comparing two or more firm is in industry

Extended Du Pont Analysis

ROE = Return on Shareholder equity

ROE= net profit margin x Total asset turnover x Equity Multiple

= (Net profit after taxes / net sales) x (Net sale /Total assets) x (Total Assets /
Shareholder Equity)

= (Net profit after taxes/Shareholders equity) *100

Why DuPont analysis is needed?

This analysis is very important for an investor as it answers the question what is actually causing
the ROE to be what it is. If there is an increase in the Net Profit Margin without a change in the
Financial Leverage, it shows that the company is able to increase its profitability.
But if the company is able to increase its ROE only due to increase in Financial Leverage, it’s
risky since the company is able to increase its assets by taking debt.
Thus we need to check whether the increase in company’s ROE is due to increase in Net Profit
Margin or Asset Turnover Ratio which is a good sign or only due to Leverage which is an alarming
signal for the company so as far as to know this we need DuPont analysis.

DuPont equation in relation to stakeholder’s point of view

The DuPont equation is less useful for some industries, that do not use certain concepts or for
which the concepts are less meaningful. On the other hand, some industries may rely on a single
factor of the DuPont equation more than others. Thus, the equation allows analysts to determine
which of the factors is dominant in relation to a company’s return on equity. For example, certain
types of high turnover industries, such as retail stores, may have very low profit margins on sales
and relatively low financial leverage. In industries such as these, the measure of asset turnover is
much more important.
High margin industries, on the other hand, such as fashion, may derive a substantial portion of
their competitive advantage from selling at a higher margin. For high end fashion and other luxury
brands, increasing sales without sacrificing margin may be critical. Finally, some industries, such
as those in the financial sector, chiefly rely on high leverage to generate an acceptable return on
equity. While a high level of leverage could be seen as too risky from some perspectives, DuPont
analysis enables third parties to compare that leverage with other financial elements that can
determine a company’s return on equity.