Du Pont Analysis
(Anand)
It is important to understand how the company''s profitability, efficiency, and leverage are linked in its financial performance, students are required to demonstrate and evaluate its Du Pont system over time. The company''s return on assets, ROA (=net income/assets), can be expressed as:
ROA = (Net Income/Revenue) * (Revenue/Assets) = profit Margin * Asset Turnover
And the company''s return on equity, ROE (=net income/equity), can be expressed as
ROE = (Net Income/Revenue) * (Revenue/Assets) * (Assets/Equity) = ROA * Equity Multiplier
Both the company''s profitability (as measured in terms of profit margin) and efficiency (as measured in terms of asset turnover) determine its ROA. This ROA, along with the company''s financial leverage (as measured in terms of its equity multiplier), contributes to its ROE. As the company''s use of leverage magnifies its ROE, students are required to examine ROE carefully. The changes in the company''s ROE are to be noted and explained through its profit margin, asset turnover, and equity multiplier over time. The objective is to identify the company''s strong area that can be capitalized upon and/or its weak area that must be improved upon.
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