The simple ROE helps in understanding the return generated by the company on its equity. Basically, in this analysis, the three components discussed above are taken into account for calculation. Let us understand the difference in calculation. There are a few changes in the calculation part when calculating ROE under the two approaches. You can also see a snapshot of DuPont Analysis Calculator below: ROE = (EBIT / Sales) x (EBT / EBIT) x (Net Income / EBT) x (Sales / Total Assets) x (Total Assets / Total Equity) Dupont Analysis Calculator Return on Equity = EBIT Margin x Interest Burden x Tax Burden x Asset Turnover Ratio x Financial Leverage The DuPont equation can be further decomposed to have an even deeper insight where the net profit margin is broken down into EBIT Margin, Tax Burden, and Interest Burden. For instance, the ROE may come down due to accelerated depreciation in the initial years. The lower ROE may not always be a concern for the company as it may also happen due to normal business operations. Once the management of the company has found the weak area, it may take steps to correct it. Say if the shareholders are dissatisfied with the lower ROE, the company with the help of the DuPont Analysis formula can assess whether the lower ROE is due to low-profit margin, low asset turnover, or poor leverage. It highlights the company’s strengths and pinpoints the area where there is a scope for improvement. It gives a broader view of the Return on Equity of the company. It will help investors to measure the risk associated with the business model of each company.Ĭlick here to calculate with the help of DuPont Analysis calculator. Thus this Analysis helps compare similar companies with similar ratios. Moreover, company B seems less risky since its Financial Leverage is very low. On the other hand, company B is selling its products at a lower margin but having very high Asset Turnover Ratio indicating that the company is making a large number of sales. The ratios of the two companies are as follows- RatioĮven though both companies have the same ROE, however, the operations of the companies are totally different.Ĭompany A is able to generate higher sales while maintaining a lower cost of goods which can be seen from its high-profit margin. ![]() Both the companies are into the electronics industry and have the same ROE of 45%. Let’s analyze the Return on Equity of Companies- A and B. Hence the leverage of the company is asįinancial Leverage = Average Assets/ Average Equity= 1000/400 = 2.5 DuPont Analysis Example Learn to evaluate a company with Company Valuation Course by Market Expertsįor example Company X has average assets of Rs 1000 and equity of Rs 400. However, usage of excess leverage to push up the ROE can turn out to be detrimental to the health of the company. The debt should be used to finance the operations and growth of the company. The companies should strike a balance in the usage of debt. This refers to the debt used to finance the assets. Hence the asset turnover is as followsĪsset Turnover= Revenues/Average Assets = 1000/200 = 5 3. If the company’s asset turnover increases, this positively impacts the ROE of the company.įor example Company X has revenues of Rs 10000 and average assets of Rs 200. This ratio differs across industries but is useful in comparing firms in the same industry. This is calculated by dividing revenues by average assets. This ratio depicts the efficiency of the company is using its assets. Net Profit Margin= Net profit/ Total revenue= 1000/10000= 10% 2. Therefore the net profit margin is calculated as The primary factor remains to maintain healthy profit margins and derive ways to keep growing it by reducing expenses, increasing prices, etc, which impacts ROE.įor example Company X has Annual net profits of Rs 1000 and an annual turnover of Rs 10000. This resembles the profit generated after deducting all the expenses. This is calculated by dividing the net profit by total revenues. This is a very basic profitability ratio. This analysis has 3 components to consider 1. Has a high Financial Leverage Components of DuPont Analysis Effectively uses its assets so as to generate more salesģ. The company can increase its Return on Equity if it-Ģ. Return on Equity = Net Profit Margin * Asset Turnover Ratio * Financial Leverage = (Net Income / Sales) * (Sales / Total Assets) * (Total Assets / Total Equity) In simple words, it breaks down the ROE to analyze how corporate can increase the return for their shareholders. ![]()
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