Du Point Analysis

Du Pont Analysis is also termed as the Du Pont Identity or Dupont Analysis. It is a representation that splits Return On Equity or ROE into three segments. The segments are the following:

Financial Leverage (calculated with the help of equity multiplier)

Asset use efficiency (calculated with the help of asset turnover)

Operating efficiency (calculated with the help of profit margin)

Return On Equity or ROE is calculated with the help of the following formula:

ROE = (Net profit/Sales) × (Sales/Assets) × (Assets/Equity)
= (Profit margin) × (Asset turnover) × (Equity multiplier)

The Du Pont Analysis decomposes the Return On Equity (i.e. the yield to equity that has been imparted by the investors to the firm) into 3 separate components. This assessment permits the financial analyst to comprehend where greater or lower return is coming from in relation to other firms in resembling types of industries (or among industries).

The Du Pont Analysis is not so helpful for a number of industries, which include the banking sector. These industries do not utilize some particular ideas or the ideas that are not so substantive. Variances can be applied in particular industries till the time they observe the fundamental form of the Du Pont Analysis.

The Du Pont Analysis is dependent on the accounting identity, which is a formula or statement true by definition.

Du Pont Analysis is utilized in the following types of industries:

• High margin industries
• High turnover industries
• High leverage industries

The Return On Investment Ratio has been formulated by the Du Pont Analysis for its own purpose. Presently, it is applied by a large number of firms for assessing the efficiency of the usage of assets. It calculates the consolidated results of asset turnover and profit margins.

It is expressed with the help of the following formula:

ROI = Net Income/Sales * Sales/Total Assets = Net Income/Total Assets

The ROE or Return On Equity Ratio is a calculation of the rate of yield to shareholders. Breaking down the ROE into different elements affecting the performance of a company is frequently termed as the Du Pont System.

It is represented with the help of the following formula:

ROE = Net Profit/Equity = Net Profit/Profit Before Tax * Profit Before Tax/EBIT * EBIT/Sales * Sales/Assets * Assets/Equity

Here, net profit is net profit after taxes
Equity refers to shareholder's equity
EBIT is Earnings Before Interest and Taxes
Sales refers to net sales

The breakup represents different types of ratios applied in fundamental analysis and they are the following:

• The interest burden of the company is (Pretax profit / EBIT). This should be 1.00 for a company with no financial leverage or debt.
• The tax burden of the company is (Net profit / Pretax profit). This is the percentage of the profits of the company held back after the payment of income taxes
• The asset turnover or ATO of the company is (Sales / Assets).
• The return on sales or ROS or operating profit margin of the company is (EBIT / Sales). That is the operating profit/dollar of sales
• The return on assets or ROA of the company is (Return on sales * Asset turnover).
• The leverage ratio of the company is (Assets / Equity) that is equivalent to the company's debt to equity ratio + 1. This is a calculation method of financial leverage.
• The compound leverage factor of the company is (Interest burden * Leverage).

ROE may also be expressed as the following

ROE = Tax burden * Interest burden * Margin * Turnover * Leverage

or ROE = Tax burden * ROA * Compound leverage factor

Here the profit margin is Net Profit/Sales. Thus the equation of ROE may be reiterated as the following:

ROE = (Net Profit/Sales) * (Sales/Assets) * (Assets/Equity)