Financial Analysis Assignment # 2

FINANCIAL ANALYSIS
ASSIGNMENT # 2
Submitted by:
Mirza Dawood L1F16BSAF0060
Submitted to: Sir Abid Noor

Section: B
Date: April 27, 2020
UNIVERSITY OF CENTRAL PUNJAB

DuPont analysis
The DuPont analysis is a framework for analyzing fundamental performance popularized by the
DuPont Corporation in 1920s. DuPont analysis is an extended analysis of a company’s return on
equity. It concludes that a company can earn a high return on equity if it earns a high profit
margin, uses its assets effectively to generate more sales and has a high financial leverage.
A DuPont analysis is used to evaluate the component parts of a company's return on equity
(ROE). This allows an investor to determine what financial activities are contributing the most to
the changes in ROE. An investor can use analysis like this to compare the operational
efficiency of two similar firms. Managers can use DuPont analysis to identify strengths or
weaknesses that should be addressed.
DuPont Analysis Components

DuPont analysis breaks ROE into its constituent components to determine which of these factors
are most responsible for changes in ROE. There are three major financial metrics that drive
return on equity (ROE) i.e. net profit margin, asset turnover and equity multiplier. Profit margin
measures operating efficiency. Asset turnover measures asset use efficiency. Equity multiplier
measures the amount of financial leverage used by the company.
Formula and Calculation of DuPont Analysis

The DuPont analysis is an expanded return on equity formula, calculated by multiplying the net
profit margin by the asset turnover by the equity multiplier.
DuPont Analysis:
ROE = Net Profit Margin × Asset Turnover × Equity Multiplier
Where,
Net Profit Margin = Net profit /Net sales
Asset turnover = Net sales / Total assets
Equity multiplier = Total assets / Shareholder’s equity
Net Profit Net Sales Total Assets
ROE = × ×
Net Sales Total Assets Shareholde r ' s Equity
So, net sales and asset turnover cancel with each other and
Net Profit
ROE =
Shareholde r ' s Equity
When DuPont analysis is needed?
This analysis is very important for an investor as it answers the question what is actually causing
the ROE to be what it is. If there is an increase in the Net Profit Margin without a change in the
Financial Leverage, it shows that the company is able to increase its profitability.
But if the company is able to increase its ROE only due to increase in Financial Leverage, it’s
risky since the company is able to increase its assets by taking debt.
Thus we need to check whether the increase in company’s ROE is due to increase in Net Profit
Margin or Asset Turnover Ratio which is a good sign or only due to Leverage which is an
alarming signal for the company so as far as to know this we need DuPont analysis.
DuPont equation in relation to stakeholder’s point of view

The DuPont equation is less useful for some industries, that do not use certain concepts or for
which the concepts are less meaningful. On the other hand, some industries may rely on a single
factor of the DuPont equation more than others. Thus, the equation allows analysts to determine
which of the factors is dominant in relation to a company’s return on equity. For example, certain
types of high turnover industries, such as retail stores, may have very low profit margins on sales
and relatively low financial leverage. In industries such as these, the measure of asset turnover is
much more important.
High margin industries, on the other hand, such as fashion, may derive a substantial portion of
their competitive advantage from selling at a higher margin. For high end fashion and other
luxury brands, increasing sales without sacrificing margin may be critical. Finally, some
industries, such as those in the financial sector, chiefly rely on high leverage to generate an
acceptable return on equity. While a high level of leverage could be seen as too risky from some
perspectives, DuPont analysis enables third parties to compare that leverage with other financial
elements that can determine a company’s return on equity.
Limitations of Using DuPont Analysis

The biggest drawback of the DuPont analysis is that, while expansive, it still relies on accounting
equations and data that can be manipulated. Plus, even with its comprehensiveness, the DuPont
analysis lacks context as to why the individual ratios are high or low, or even whether they
should be considered high or low at all.

Financial Analysis Assignment # 2

Uploaded by

Copyright:

Available Formats

Financial Analysis Assignment # 2

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Financial Analysis Assignment # 2

Uploaded by

Copyright:

Available Formats

FINANCIAL ANALYSIS

Submitted to: Sir Abid Noor

UNIVERSITY OF CENTRAL PUNJAB

DuPont Analysis Components

Formula and Calculation of DuPont Analysis

DuPont equation in relation to stakeholder’s point of view

Limitations of Using DuPont Analysis

You might also like