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Du pont analysis 

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The gist of Du Pont Analysis

The gist of Du Pont Analysis

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  • 1. DU Pont AnalysisThe Du Pont Company of the US pioneered a system of financial analysis, which has received widespread recognitionand acceptance. This system of analysis considers important interrelationships between different elements based on theinformation found in the financial statements.The Du Pont analysis can be depicted via the following chart:At the apex of the Du Pont chart is the Return On Total Assets (ROTA), defined as the product of the Net Profit Margin(NPM) and the Total Assets Turnover Ratio (TATR). As a formula this can be shown as follows:(Net profit/Total asset)= (Net profit/Net sales)*(Net sales/Total assets) (ROTA) (NPM) (TATR)Such decomposition helps in understanding how the return on total assets is influenced by the net profit margin and thetotal assets turnover ratio.The left side of the Du Pont chart shows details underlying the net profit margin ratio. A detailed examination of thisside presents areas where cost reductions may be effected to improve the net profit margin.The right side of the chart highlights the determinants of total assets turnover ratio. If this study is supplemented by thestudy of other ratios such as inventory, debtors, fixed asset turnover ratios, a deeper insight into efficiencies andinefficiencies of asset utilization can be sought.The basic Du Pont analysis can be extended to explore the determinants of the Return On Equity (ROE).
  • 2. Return on equity= Asset turnover * Net profit margin*leverage(Net profit/Equity)= (Net profit/Sales)*(Sales/Total assets)*(Total assets/Equity) (ROE) (NPM) (TATR) 1/(1-DR)Where DR is the debt ratio= debt (D)/assets (A)Breaking ROE into these three parts allows evaluation of how well one can manage the company’s assets, expenses, anddebt. A manager has basically three ways of improving operating performance in terms of ROA and ROE. These are: • Increase capital asset turnover • Increase operating profit margins • Change financial leverageEach of these primary drivers is impacted by the specific decisions on cost control, efficiency productivity, marketingchoices etc.Importance of Dupont AnalysisAny decision affecting the product prices, per unit costs, volume or efficiency has an impact on the profit margin orturnover ratios. Similarly any decision affecting the amount and ratio of debt or equity used will affect the financialstructure and the overall cost of capital of a company. Therefore, these financial concepts are very important to evaluateas every business is competing for limited capital resources. Understanding the interrelationships among the variousratios such as turnover ratios, leverage, and profitability ratios helps companies to put their money areas where the riskadjusted return is the maximum.

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