DuPont analysis is a useful technique to break down the different return on equity (ROE) generators. The ROE decomposition helps investors to concentrate separately on key indicators of financial success to define strengths and weaknesses. Three main financial metrics drive equity return (ROE): operating performance, asset usage performance, and financial leverage. Operating output is a net profit margin or a net income separated by overall revenue or profits. The efficiency of asset usage is determined by the turnover ratio of the assets. Leverage is calculated by the equity multiplier, equal to average assets divided by average equities. The component parts of a firm's return on equity (ROE) are calculated using a DuPont analysis. This allows an investor to assess, which financial activities contribute the most to the ROE changes

1. Presentation
DuPont Analysis

2. Return on
Equity
Profitability
Asset
Efficiency
Leverage
DuPont
Analysis
breaks down
the ROE to
analyze how
corporate can
increase the
return for
their
shareholders.
DuPont Analysis

3. Return
on Equity
[ROE]
Net Income
Shareholder’s
Equity
Return on Equity
FORMULAS

4. Components of DuPont Equation
This ratio depicts the
efficiency of the
company in using its
assets. This is
calculated by
dividing revenues by
average assets. This
ratio differs across
industries but is
useful in comparing
firms in the same
industry.
This refers to
the debt usage
to finance the
assets. The
companies
should strike a
balance in the
usage of debt.
The debt should
be used to
finance the
operations and
growth of the
company.
As an aspect of
the DuPont
model, if the
profit margin of a
company
increases, each
successive sale will
bring in more cash
flow to the
company,
ultimately leading
to a higher overall
return on equity.
Profit Margin Total Asset Turnover Financial Leverage

5. Example
As we can see, both ABC and XYZ (that
operate in the same industry) have the
same ROE.
But the weightage of different
components varies.
Ratio ABC XYZ
Profit Margin 50% 35%
Total Asset Turnover .30 3.0
Financial Leverage 3.5 .50
Return on Equity 0.5*.3*3.5 = .525 =0.35*3*.5 = .525

6. Importance of DuPont Analysis
The DuPont model is of great importance because it doesn't just want to
know what return on equity is, rather it allows you to identify which
specific variables are causing the ROE in the first place.
By measuring and highlighting those
underlying realities, it becomes easier
to analyze & improve them (if
required) and take better decisions.
Its important to understand whether the company is
generating profits through internal accruals or
through Debt Financing or through raising Equity.

7. 5-step DuPont Model
• Five-step DuPont model isolates operations and financial impacts
on ROE, where we try to see the effect of interest expense on the
Net Profit Margin.
• Both the three-and five-step equations, give a better
understanding by analyzing all factors separately rather than just
looking at a simple ratio.
Return
on Equity
[ROE]
Tax
Burden
Assest
Turnover
Equity
Multiplier
Interest
Burden
Operating
Margin

8. Thus, we need to check whether the
growth in company’s profitability is
due to increase in Net Profit Margin
or Asset Turnover Ratio (which is a
good sign) or only due to Financial
Leverage (which is bad news).
Conclusion