DuPont analysis is called the DuPont model which is the financial ratio. This model is based on return on equity ratio which is used to calculate the ability of the company to increase its returns on the equity.
In other words for the breakdown of return on equity ratio, it explained that how a company can increase its return for investors.
For the increment of return for investors, the company need three component of ROE ratio which are given below:
What are the three components of the DuPont identity?
A company can increase the return on equity for investors by maintaining the increment in profit margin, financial leverage, total assets turnover.
Dupont analysis developed by the DuPont Corporation in 1920.
Dupont analysis formula can be calculated by the product of profit margin, financial leverage, and total assets turnover (DuPont Analysis = Return on equity)
Return on Equity = profit margin x financial leverage x total assets turnover
For the profit margin, leverage financial and total asset turn over there are formulas which can be used in the above formula for the calculation of DuPont analysis.
To analyze the return on equity (ROE) DuPont analysis model was developed. To find the causing of the current ROE this model is used.
If in any company investors are not happy due to the low ROE of that company then management uses this model to analyze whether the profit margin low, financial leverage poor or total turnover assets is not good.
From this model, management can point out that there are problems and then management correct that area where is the problem.
Now we take the example of two retailers companies which work under the same industry and have the same ROE ratio which is 45%.
To analyze the weak and strong point of these companies we use the DuPont model.
Ratio Company A Company B
Profit margin 30 % 15%
Total Asset Turnover .50 6.0
Financial leverage 3.0 .50
ROE for both companies is the same but have the difference in ratios component.
45% =.30 x .50 x 3.0
45% =.15 x 6.0 x .50
Company a sold product on high-profit margin but the cost of goods low. It is difficult for the company it is difficult to sales a large number of sales.
On the small profit margin company sold product but it turning over a lot of product. So it has low-profit margin but high assets turnover.
From this model, investors can compare similar companies with a similar ratio
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