ADVANCED

STRATEGIC
MANAGEMENT

Submitted to Submitted by

Dr Aparna Sajeev Namitha .K

What is DuPont Analysis?
The DuPont Analysis, also known as the DuPont Identity, is a
fundamental framework for performance assessment. It can be used to
analyse the various factors influencing the returns that investors receive
from the organisation.

This is also referred to as the Return on Equity: the ratio between the
profits of a company and the capital used to achieve these profits. This
business-economic analysis is a tool that can help accountants and
financial managers to analyse a company’s profitability without drawing
misleading conclusions.

The DuPont Analysis method breaks down and clarifies the different
components of the Return on Equity (ROE) formula, which can help
companies with finding ways to improve their return on equity.
Organisations mostly use this method to improve their own performance
and to increase the return that they can offer to investors and
shareholders.

The DuPont Analysis got its name from the DuPont Corporation. This
large, American company was founded in 1802 as a gunpowder mill by
French-American chemist and industrial expert Eleuther Irenee du pont.
They developed several different polymers, including neoprene, nylon
and Kevlar in the 20th century, and they became very well known in the
chemical industry. The company currently has 33,000 employees and is
ranked number 176 on the Forbes list.
How do you calculate DuPont analysis?
The DuPont Analysis uses three interrelated components to calculate the
Return on Equity (ROE). The breakdown into three distinct components
makes it possible to establish which of the three components has the
biggest impact on changes or fluctuations of the Return on Equity.

Despite the fact that the DuPont Analysis can be used to calculate the
profitability of a company in relation to its assets, this isn’t the method’s
main objective. The goal is to determine which factors influence the
ROE, so that the Management knows which problems to address.
The formula used to calculate the ROE is as follows:

ROE = Profit Margin × Asset Turnover × Financial Leverage

The three components after the equals sign are important elements:

 Profit Margin: the difference between turnover and profits

 Asset Turnover: the difference between turnover and assets used

 Financial Leverage: the relationship between profitability and the

costs of borrowed capital

To complete the above formula, you need to start with calculating the
three separate ratios. These ratios can be calculated using data from the
organisation’s balance sheet and income statement. You can find these
financial management overviews in the financial part of an
organisation’s annual report.

The brackets in the formula below demonstrate how both the ratios and
the ROE are calculated:

ROE = (Net Income/Net Sales) × (Net Sales/Total Assets) × (Total

Assets/Total Shareholders’ Equity
DuPont Analysis example: Organisation X
The financial overviews of organisation X can be summarised as
follows:

Organisation X has agreed to pay out 15,000 euros of dividends. Profit

distributions should be distracted from the net income. Based on the
details above, the three parentheses are calculated as follows:

 Profit Margin = (Net Income/Net Sales) = (87,000-15,000)/420,000 x

100% = 17.14%
 Asset Turnover = (Net Sales/Total Assets) = 420,000/473,000 = 0.89

 Equity multiplier = (Total Assets/Total Shareholders’ Equity) =

473,000/358,000 = 1.32 (Financial leverage)

Following the DuPont calculation, organisation X’s Return on Equity is:
ROE = 17.14% x 0.89 x 1.32 = 20.14%
What does this ROE mean to investors and analysts?
Organisation X has a 20.14% ROE. This means that
organisation X generates 0.2014 euro for each euro of their
equity capital. For potential investors, this is an important
number, because it shows how efficiently a company uses their
money to increase their net income.

The average ratios covering around 5 to 10 years, provide quite

a realistic image of an organisation’s development. Business
growth or a higher ROE doesn’t necessarily imply that profits
are distributed among shareholders. But they will eventually
benefit from the value increase of the shares.

Business-economic analysts can use the DuPont method to

analyse an organisation and establish what the company’s
strengths and weaknesses are, and how they can improve, in an
efficient way. Generally speaking, analysts feel that companies
with an ROE of less than 12-14% are too high risk to invest in.

Investments in organisations with an ROE of 20% or more, are

considered justified and solid investments. The profitability
(ROE) of Apple Inc., for example, increased from 17.88% in
2005 to 36.07% in 2017. Investors are always told to be careful
with organisations that have a negative ROE, as they are often
confronted with problems related to excessive debts.
Pros and cons of the DuPont Analysis
 The DuPont Analysis is an excellent method if you want to get an
understanding of a company’s strengths and weaknesses. Each
individual weak financial ratio in the model can be analysed further
in order to get more insight in the underlying reason for that
weakness.
If the calculation of the three components of the DuPont analysis
reveals any weaknesses, the Management can take measures, such as
improving their cost control, assets management or marketing. The
objective of all these measures is to increase the return on equity
ratio.

 A disadvantage of the DuPont Analysis is that the financial

overviews that are used to calculate the ROE might have been
manipulated in order to hide certain shortcomings. If you want to be
sure that the outcomes are correct, you need to use accurate
accounting data.
 Another disadvantage is inherent to all financial ratio analysis
methods. Comparing an organisation’s profitability and efficiency
with that of another organisation works best when the two companies
have the same size and operate in the same industry.