DuPont analysis

DuPont identity is also know as DuPont analysis, DuPont method DuPont equation, or DuPont Model, is an expression that breaks return of equity into three sections. During 1920s the DuPont Corporation started using this equation from where the actual name comes from. 

The basic equation of DuPont method is as follows:

Return of equity = profit margin x asset turnover x equity multiplier = Net sales or profit x assets or sales x equity or assets = net equity or net profit.

• Operating efficiency is measured by profit margin.
•  Financial leverage is measure by equity multiplier
• Assets use efficiency is measured by assets turnover.

Return on Equity

The DuPont analysis breaks down the REO (i.e. the returns which investors obtain from the company or business organization) into three elements.  The DuPont analysis or equation allows the person or analyst to know the sources of the inferior or superior return by comparing between industries or with business organizations in the sale field or industries. Du Pont equation, however, is less functional for a few of the industries, like investment banking, which don’t use certain theory or concepts or for that the concepts are less important.  Variations might be used in some industries, only when they respect the underlying structure of the DuPont method. The Du Pont analyses depend upon the accounting identity, which is, a formula or statement that is by meaning or definition true.

Some of the industries use the DuPont method is as follows

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

It is considered that valuing assets at gross book value would eliminate the incentive in order to avoid investing in the new assets. New asset avoidance could occur as financial accounting depreciation systems artificially produce lower return on equity in the starting years which an asset is placed into service. If return on equity unsatisfactory, the DuPont methods assist to find out the part of the business which is underperforming.

Questionnaire:

• What is DuPont method?
• What is the formula of the DuPont method?