The DuPont Analysis is an approach that breaks down ROE (Return on Equity) into a function of 3 or 5 ratios that helps to see the impact of each ratio on ROE.
Suppose you are going through the financial ratios of our company and stop at ROE and wondering what are the factors that are contributing or impacting the ROE. You called your accountant and asked him to find the means through which factors impacting ROE can be tracked. Considering your concern, the accountant is explaining you the two variants of DuPont Analysis.
The three part approach
The extended five part approach
Now multiply (Revenue/Revenue) with the above mentioned formula and re-arrange the terms
Now multiply (Total Assets/Total Assets) and re-arrange the terms
If we further breaks down the Net Profit Margin, it becomes the extended five part DuPont equation.
Therefore the extended DuPont equation is
Step 1: Calculate the Net Profit Margin
Step 2: Calculate the Asset Turnover Ratio
Step 3: Calculate the Financial Leverage
Step 4: Finally multiply all the three ratios to calculate the ROE
Step 1: Calculate the Tax Burden
Step 2: Calculate the Interest Burden
Step 3: Calculate the EBIT Margin
Step 4: Calculate the Asset Turnover Ratio
Step 5: Calculate the Financial Leverage
Step 6: Finally multiply the entire above calculated ratio together to get the ROE
I have created a Dupont Analysis template for you, where the subheadings are given and you have to link the model to get the cash numbers! You can download the same from here. You can go through the case and fill in the yellow boxes. I also recommend that you try to create this structure on your own (so that you get a hang of what information is to be recorded).
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