DuPont Analysis

DuPont Corporation's management created the DuPont Analysis model in the 1920s to provide a detailed assessment of the company's profitability. DuPont Analysis is a tool that can help us avoid drawing incorrect inferences about a company's profitability. DuPont analysis is a valuable technique for breaking down the many determinants of return on equity (ROE). The deconstruction of ROE enables investors to focus on important financial performance parameters independently in order to discover strengths and flaws.

The DuPont analysis, popularised by the DuPont Corporation, is a methodology for analysing fundamental performance.
Donaldson Brown, a DuPont Corporation employee, invented the formula in 1914.
DuPont analysis is a valuable tool for breaking down the various drivers of return on equity.
An investor can use this type of analysis tool to assess the operational efficiency of two similar organisations.
Using DuPont analysis, managers can discover strengths and shortcomings that need to be addressed.

DuPont Analysis

The basic DuPont Analysis approach divides the original ROE calculation into three components: operating efficiency, asset efficiency, and leverage. Net Profit Margin, which reflects the amount of net income made per dollar of sales, is a measure of operating efficiency. Total Asset Turnover measures asset efficiency and shows the number of sales generated per unit of assets. Finally, the Equity Multiplier determines financial leverage.

DuPont Analysis = Net Profit Margin× AT× EM

where,

Net Profit Margin=Net Income ÷Revenue/Sales

Asset turnover ( AT) =Sales ÷ Average Total Assets

Equity multiplier (EM) =Average Total Assets ÷Average Shareholders’ Equity

Five Steps DuPont Model

The basic DuPont Analysis model does not separate operating activities from finance activities. A five-step DuPont model can provide opportunities in resolving the issue of the relationship between leverage and profit margin. In this model, further deconstruct the components used in the basic model in order to isolate operational and financial impacts on ROE.

DuPont Analysis = Net Profit Margin× AT× EM

Steps 1 - Begin with a breakdown of Net Profit margin i.e. Net profit Margin =Net Income÷ Sales

Steps 2 -afterwards isolate the effects of interest expenses on net margin,

Net profit Margin = Net Income ÷ Sales = EBIT ÷ Sales

= [{EBIT- Interest x (1- Tax rate)} ÷Sales]= [{EBT x ( 1-Tax rate)} ÷ Sales]

Steps 3 -Then rearranging the equation components as follows,

ROE= (EBT÷ Sales) X (sales ÷ Average total Assets) x {Average total assets ÷ Average shareholder's Equity ) x (1-tax rate)

or

DuPont = (Net Income ÷ EBT or Pre-tax Income) x (Revenue ÷ Total Sales x (Total Assets ÷ Shareholders Equity ) x (Pre-tax income ÷ Operating Income ) x (Operating Income ÷ Revenue )

Examples of 3-step and 5-step DuPont Analysis

Model / Elements Lower Base Upper

+ Revenue 200 250 300

- Cost of Goods Sold 140 150 160

= Gross Margin 60 100 140

- Operating Expenses 40 50 60

= Operating Income (EBIT)20 50 80

- Interest 0 10 20

= Pre-Tax Income 20 40 60

- Tax 25% 5 10 15

= Net Income 15 30 45

Average Total Assets 500 450 400

Average Shareholders Equity 500 400 300

3 Step DuPont Lower Base Upper

Net Profit Margin 8% 12% 15%

Total Assets Turnover 0.4x 0.6x 0.8x

Equity Multiplier 1.0x 1.1x 1.3x

ROE 3% 8% 15%

5 Step DuPont Lower Base Upper

Tax Burden 0.75x 0.75x 0.75x

Total asset Turnover 0.4x 0.6x 0.8x

Equity Multiplier 1.0x 1.1x 1.3x

Interest Burden 1.0x 0.8x 0.8x

Operating Margin 10% 20% 27%

ROE 3% 8% 15%

Further Notes for Calculations

Net Profit Margin = Net Income ÷ Revenue

Total Asset Turnover = Revenue ÷ Total Assets

Financial Leverage Ratio/ Equity Multiplier = Total Assets ÷ Shareholders' Equity

Tax Burden = Net Income ÷ Pre-Tax Income

Total Asset Turnover = Revenue ÷ Total Assets

Financial Leverage Ratio = Total Assets ÷ Shareholders' Equity

Interest Burden = Pre-Tax Income ÷ Operating Income

Operating Margin = Operating Income ÷ Revenue

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