DU Pont Analysis
The
Du Pont Company of the US pioneered a system of financial
analysis, which has received widespread recognition and
acceptance. This system of analysis considers important
interrelationships between different elements based on the
information 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 the total
assets turnover ratio.
The
left side of the Du Pont chart shows details underlying
the net profit margin ratio. A detailed examination of this
side 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
the study of other ratios such as inventory, debtors, fixed
asset turnover ratios, a deeper insight into efficiencies
and inefficiencies of asset utilisation can be sought.
The
basic Du Pont analysis can be extended to explore the determinants
of the Return On Equity (ROE).
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/(1DR)
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, and debt.
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 leverage
Each
of these primary drivers is impacted by the specific decisions
on cost control, efficiency productivity, marketing choices
etc.
Importance
of Dupont Analysis
Any
decision affecting the product prices, per unit costs, volume
or efficiency has an impact on the profit margin or turnover
ratios. Similarly any decision affecting the amount and
ratio of debt or equity used will affect the financial structure
and the overall cost of capital of a company. Therefore,
these financial concepts are very important to evaluate
as every business is competing for limited capital resources.
Understanding the interrelationships among the various ratios
such as turnover ratios, leverage, and profitability ratios
helps companies to put their money areas where the risk
adjusted return is the maximum.
