In finance, understanding a company’s profitability is crucial for investors and analysts alike. DuPont analysis, a widely used financial tool, provides a comprehensive breakdown of a company’s return on equity (ROE), revealing the underlying factors that contribute to its overall profitability. Much like peeling back layers of an onion, DuPont analysis dissects ROE into its constituent parts, allowing for a deeper appreciation of a company’s financial health.
ROE is composed of three instruments: operating efficiency, asset efficiency, and financial leverage. Operating efficiency, represented by the net profit margin, measures a company’s ability to generate profits from its sales. Asset efficiency, embodied by the asset turnover ratio, reflects how effectively a company utilizes its assets to produce revenue. Financial leverage, captured by the equity multiplier, indicates the extent to which a company employs debt to finance its operations.
Now, if it seems difficult to understand, here is an interesting version of the above:
Imagine you’re baking a delicious cake. To make sure it turns out perfect, you would check the ingredients like flour, eggs, and sugar, right? DuPont analysis is like that for businesses. It’s a way to look at different ingredients that make up a company’s financial success.
Net Profit Margin
Net Profit Margin is like the icing on your cake. It tells us how much profit a company makes from its sales. If the profit margin is high, it means the company is making more money from each sale. That’s a good sign. To arrive at the net profit margin we divide shareholders profit by revenue or sales as shown in the formula.
- Formula: Net Profit Margin = Net Profit/Sales
Asset Turnover
Asset Turnover is like how well you mix your cake batter. It shows how efficiently a company is using its assets like money, equipment, and inventory to generate sales. A higher asset turnover means the company is using its resources wisely. To determine asset turnover we divide sales by total assets as given below.
- Formula: Asset Turnover = Sales/Total Assets
Equity Multiplier
Equity Multiplier is like the size of your cake. It measures how much debt a company is using to finance its assets. If the company has too much debt, it’s like using too much flour in your cake—it might not turn out so well. A lower equity multiplier is generally better. To know the financial leverage known as equity multiplier total assets are divided by total equity.
- Formula: Equity Multiplier = Total Assets/Total Equity
Putting it all together we get a perfect cake. Now, here comes the fun part, DuPont Analysis combines these three ingredients to give us a complete picture of a company’s financial health.
Return on Equity – ROE
ROE is like taking a big bite of your cake to see if it is as delicious as it looks. It is the final result of DuPont Analysis. ROE tells us how well a company is using its resources to generate profits for its shareholders. A higher ROE means the company is doing a fantastic job. The ROE is simple to calculate but expansion of its formula arrives at DuPont analysis. DuPont analysis is the multiplication of 3 components which are profit margin, asset turnover and financial leverage.
- Formula: ROE = Net Profit/Equity
But, in DuPont –
ROE = Profit Margin * Asset Turnover * Equity Multipliers
In a more simplified way,
- ROE =
(Net Profit Margin/Sales) * (Sales/Total Assets) * (Total Assets/Total Equity) - ROE =
(Net Profit Margin/Sales) * (Sales/Total Assets) * (Total Assets/Total Equity) - ROE = Net Profit Margin/Total Equity
This is how we arrive at Return on Equity through DuPont Analysis.
|
Return on Equity (ROE) |
|||||
| Mar-19 | Mar-20 | Mar-21 | Mar-22 | Mar-23 | |
| Net Profit | 1,159.1 | 1,402.6 | 1,863.9 | 1,524.8 | 2,321.8 |
| Average Shareholder Equity | 3,829.7 | 4,328.0 | 3,975.2 | 3,052.9 | 3,046.2 |
| Return on Equity | 30.27% | 32.41% | 46.89% | 49.95% | 76.22% |
ROE – Dupont Equation |
|||||
| Mar-19 | Mar-20 | Mar-21 | Mar-22 | Mar-23 | |
| Net Profit | 1,159.1 | 1,402.6 | 1,863.9 | 1,524.8 | 2,321.8 |
| Revenue | 11,054.7 | 11,599.6 | 13,136.1 | 14,136.3 | 16,300.6 |
|
Net Profit Margin (A) |
10.49% | 12.09% | 14.19% | 10.79% | 14.24% |
| Revenue | 11,054.7 | 11,599.6 | 13,136.1 | 14,136.3 | 16,300.6 |
| Average Total Asset | 5,712.9 | 7,033.7 | 7,914.8 | 7,763.3 | 8,438.7 |
|
Asset Turnover Ratio (B) |
1.9x | 1.6x | 1.7x | 1.8x | 1.9x |
| Average Total Asset | 5,712.9 | 7,033.7 | 7,914.8 | 7,763.3 | 8,438.7 |
| Average Shareholder Equity | 3,829.7 | 4,328.0 | 3,975.2 | 3,052.9 | 3,046.2 |
|
Equity Multiplier (C) |
1.49x | 1.63x | 1.99x | 2.54x | 2.77x |
|
Return on Equity (A*B*C) |
30.27% | 32.41% | 46.89% | 49.95% | 76.22% |
In the above table, we have given a DuPont analysis of Britania industries for the last 5 years.
Check: Profitable FMCG Companies
We can understand that Profit Margin has shown a positive trajectory, starting at 10.49% in the year 2019, steadily increasing to 14.19% in the year 2021, with a slight dip in the year 2022 at 10.79%, followed by a notable rebound to 14.24% in the year 2023. This suggests a generally improving profitability over time.
Asset Turnover Ratio experienced a decline from 1.9x in year 2019 to 1.6x in year 2020, indicating less efficiency in utilizing assets. However, it then recovered and has been on an upward trend since, reaching 1.9x in the year 2023, signaling a positive shift in asset utilization.
Know: What Is The Inventory Turnover Ratio?
Equity Multiplier reveals a consistent upward trend, starting at 1.49x in 2019 and steadily increasing to 2.77x in 2023. This suggests a growing reliance on debt to finance assets, which can pose risks but may also be a strategic move for expansion.
