The Dupont Analysis: Definition, Formula and Examples
By Indeed Editorial Team
Published 8 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Financial advisors and investors often use the DuPont return on equity analysis model to attain important information about the capital structure of a company and its returns on equity. This helps them learn more about a company's financial performance and make more informed investment decisions. Understanding what a DuPont analysis is can help you prepare for a career in finance. In this article, we discuss what the DuPont analysis model is and explain its formula and components.
What is a DuPont analysis?
The DuPont analysis is a multi-step financial framework that gives you more information on the fundamental performance of a company. The framework helps you calculate a company's return on equity to find out more about its strengths and weaknesses. This financial equation is also commonly referred to as the DuPont model. The DuPont model originated from the DuPont Corporation, a company that created this model during the 1920s.
Formula for calculating the DuPont model
The DuPont model is an expanded version of the return on equity formula. This formula uses three factors that break down the original equation for the return on equity. The factors are the total asset turnover, equity multiplier and the total asset turnover. To calculate it, you multiply the net profit margin of a company by its asset turnover using the equity multiplier. The framework shows that a company can have an increased return on equity if they maintain a high-profit margin by utilising its assets effectively to increase its asset turnover. Here's the equation for the Dupont model:
DuPont analysis = Net profit margin x Asset turnover x Equity multiplier
The three components all represent the result of a different formula. When you replace each component in the DuPont model with the original formulas of the components, the equation becomes like this:
DuPont analysis = (Net income / Revenue) x (Sales / Average of total assets) x (Average of total assets / Average of equity shareholders hold)
The components of the DuPont model
Here's more information about the DuPont model's three components:
Net profit margin
A company's net profit margin shows a representation of its remaining percentage of profits after deducting its expenses. To calculate a company's net profit margin, you divide its net profit by its total revenue. Here's the formula to calculate the net profit margin:
Net profit margin = Net income / Revenue
A business analyst usually calculates a company's net profit margin as a measure of its profitability. An increase in a company's net profit margin typically signals an increase on its return on equity. The net profit margin concept shows that a company can get better profit margins if they increase their prices, reduce their costs or use a combination of both methods.
Total asset turnover
A total asset turnover represents the efficiency of a business when it comes to using its assets to generate revenue. You can calculate a company's total asset turnover by dividing its revenue by its average assets. Here's the equation you can use to find the total asset turnover of a company:
Total asset turnover = Revenue / Average assets
An increase in a company's total asset turnover also leads to an increase on its return on equity. A company's total asset turnover ratio is usually inversely related to its net profit margin. The higher a company's net profit margin is, the lower its asset turnover rate is. Knowing this can help investors compare a company that uses a high-profit and low-volume business model with another that does the opposite. This knowledge can help them decide which company is more effective in getting a return on equity.
An equity multiplier refers to the measurement of a company's financial leverage and shows how much of its return on equity ratio results from debt. To calculate a company's equity multiplier, you can divide its average total assets by the company's average shareholders' equity. Here's the formula for finding a company's equity multiplier:
Equity multiplier = Average assets / Average equity
When a company's equity multiplier goes up in value, it also leads to an increase in its return on equity ratio. Ideally, a company wants to be able to use its assets to finance its growth and operational costs without incurring too much debt. This also helps to keep the equity multiplier low. Using the equity multiplier, the DuPont model helps investors analyse and determine how much of a company's financial assets they can leverage when making any investments.
Differences between the DuPont model and return on equity formulas
While both the DuPont model and return on equity formula may seem similar, investors may use them for different purposes. The return on equity formula shows a company's return on equity ratio, while the DuPont mode formula helps determine the impact that each component of the return on equity has on a company's return on equity ratio. Investors also tend to prefer the DuPont model formula, since it's more comprehensive in providing insights on the performance markers that drive a company's return on equity.
Knowing the DuPont framework's formula also helps investors and finance managers find out a company's strengths and what opportunities they can take to boost its return on equity. Investors also typically use this framework to make better decisions on the company's investments while comparing them to other companies' return on equity ratios. They also tend to compare the company only with their competitors, since the return on equity for companies may differ by industry.
DuPont model example
To better understand the DuPont analysis model, here's an example you can refer to:
A company's investor is choosing between two companies from the same industry to invest in. The investor is planning on using the DuPont model framework to compare the strengths and opportunity areas of each company to find out which is worth investing in. First, he gathers the financial information of each company:
Net income: $5,000
Average assets: $6,000
Average equity: $3,000
Net income: $6,000
Average assets: $6,500
Average equity: $3,500
After collecting the financial information for each company, he can use the following calculations to attain the numbers he requires for each component of the framework:
Net profit margin example
To calculate the company's net profit margin, the investor can use both company's revenue and net income to find it:
Ulysses Corporation's net profit margin = Net income / Revenue $5,000 / $8,000 = 0.625
Odysseus Company's net profit margin = Net income / Revenue = $6,000 / $9,000 = 0.667
Total asset turnover example
After finding the net profit margin, the investor can proceed to calculate the companies' total asset turnover using the company's average assets and revenue:
Ulysses Corporation's total asset turnover = Revenue / Average assets = $8,000 / $6,000 = 1.333
Odysseus Company's total asset turnover = Revenue / Average assets = $9,000 / $6,500 = 1.385
Equity multiplier example
After calculating the other two components, the investor can then calculate both companies' equity multiplier using their average assets and average equity:
Ulysses Corporation's equity multiplier = Average assets / Average equity - $6,000 / $3,000 = 2
Odysseus Company's equity multiplier = Average assets / Average equity = $6,500 / $3,500 = 1.857
DuPont model framework example
Using the calculations from the individual components, the investor can now calculate the company's total return on equity using the DuPont analysis formula:
Ulysses Corporation's DuPont analysis return on equity = Net profit margin x Asset turnover x Equity multiplier = 0.625 x 1.333 x 2 = 1.667
Odysseus Company's DuPont analysis return on equity = Net profit margin x Asset turnover x Equity multiplier = 0.667 x 1.385 x 1.857 = 1.715
From using the DuPont model framework, the investor can see that Odysseus Company has a higher return on equity ratio compared to Ulysses Corporation. With the calculations, the investor can also see how much of the company's return on equity comprises its three components. Using this information, the investor decides to invest with Odysseus Company.
Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.
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