DuPont Analysis: It
is a financial ratio used to analyse the return on equity (ROE) of company to
ascertain the reason of low or high ratio. It was developed by DuPont
Corporation in 1920. DuPont analysis tells that the return on equity (ROE) is
comprised of three components:
·
Net Profit margin
·
Total Assets turnover
·
Financial leverage
If the return on equity (ROE) is low then these 3 components
help to find out the real reason of low ROE. By improving the percentage of
profit margin, assets turnover and financial leverage company can improve its
return on equity ratio. To increase or improve the return on equity of a
company DuPont analysis help by improving the percentage of these 3 ratios.
With the help of DuPont analysis investors can find out the best investment
option.
Formula for Return on
Equity:
ROE = (Net income/ Total equity) * 100
Net Profit Margin: It
is calculated as net income divide by total revenue. It shows in percentage. It
tells the efficiency of a company to convert its sales into revenue. The higher
percentage shows the company is able to earn profit.
Formula for Profit
Margin:
Net profit margin = (Net income/Total revenue) * 100
For example: Suppose the net profit of the company is Rs.
60, 000 in year 2012. The total revenue of the company is Rs. 2, 00, 000. The
net profit margin of the company is:
Net profit margin = (Net income/Total revenue) * 100
= (60,000 / 2, 00, 000) * 100
= 30%
Total Assets
Turnover: It is calculated as net sales divided by average total assets. It
tells about the efficiency of a company to use assets to generate the revenue.
The higher ratio show that the company is efficiently uses its assets to
generate the revenue.
Formula for Total
Assets Turnover:
Total Assets Turnover = Net sales / Average total assets
For example: Suppose the net sales or total revenue is Rs.
5, 00, 000. The total asset of a company is Rs. 80, 00, 000.The assets turnover
ratio of a company is:
Total assets turnover ratio = Net Sales / Average total
assets
= 5, 00,000 / (80, 00,000/2)
= 5, 00, 000 / 40, 00, 000
= 0.125 or 12.5%.
Financial leverage or
Equity Multiplier: Financial leverage means using more debt funds to raise
capital for purchasing the assets for a company. Using more debt funds in
comparison to equity capital or preference share capital increases the payment
of interest but in other hand it reduces the earnings per share. The earnings
of shareholders are increases which is one of the main motives of the company.
Formula for Financial
leverage:
Financial leverage = Total assets / Total Equity
Or
Degree of financial leverage = Percentage of Change in
Earnings per share (EPS) / Percentage of Change in Earnings before Interest and
Tax
For example: Suppose the total asset of a company is Rs. 6,
00,000. The total equity of a company is Rs. 8, 50,000. The financial leverage
ratio is:
Financial leverage = Total assets / Total Equity
= 6, 00,000 / 8, 50, 000
= 0.70 or 70.5%
Example: A furniture manufacturing company total revenue in 2017 is Rs. 55, 65, 000 and in 2018 Rs. 75, 70, 000. The gross profit of 2017 is Rs. 6, 45, 900 and Rs. 3, 58, 000. The total operating income in 2017 is Rs. 1, 79, 860 and in 2018 is Rs. 88, 640. The total shareholder’s equity is Rs. 8, 00,500. The total asset of a company is Rs. 4, 30,000 and in 2018 is Rs. 5, 00, 000. Find out the return on equity of 2017 year.
Solution: Return on equity (ROE) of 2017 year = total assets / shareholders equity
= 4, 30, 000 / 8, 00, 500
= 0.53 or 53.71%
Return on equity (ROE) of 2018 year = total assets / shareholders equity
= 5, 00, 000 / 8, 00, 500
= 0.62 or 62.47%
Example: There are 2 companies Company PQR and ABC Company. The company PQR is manufacturing soaps and Company ABC deodorant. The market share of both the company is equal. The revenue of Company PQR is Rs. 15, 26, 000 and Rs. 18, 23, 000 of company ABC. The debenture of company ABC is Rs. 6, 00, 000 and shareholders equity is Rs. 3, 20, 000. Company PQR has Rs. 2, 20, 000 Debenture and Rs. 1, 00, 000 Preference Share capitals and Rs. 4, 00,000 Share capitals. An investor wants to know which company has more ability to increase his profit or improve his earnings level with the help of DuPont’s analysis. Other information is given below:
Particulars
|
Company PQR Amount (in Rs.)
|
Company ABC Amount (in Rs.)
|
Gross profit
|
3, 80, 000
|
2, 70, 000
|
Total operating expenses
|
45, 000
|
62, 000
|
Interest on debenture
|
6%
|
6.2%
|
Tax
|
30%
|
30%
|
Total assets
|
3, 90,600
|
2, 85, 000
|
Solution:
Particulars
|
Company PQR Amount (in Rs.)
|
Company ABC Amount (in Rs.)
|
Gross profit
|
3,80, 000
|
2, 70, 000
|
Less: total operating expenses
|
45, 000
|
62, 000
|
Earnings before interest and tax
|
3, 35, 000
|
2, 08, 000
|
Less: Interest on debenture
|
36, 000
|
13, 640
|
Earnings before tax
|
2, 99, 000
|
1, 94, 360
|
Less: Tax
|
89, 700
|
58, 308
|
Net income
|
2, 09, 300
|
1, 36, 052
|
Total assets
|
30, 90,600
|
32, 85, 000
|
Company PQR:
Net Profit Margin = (Net income / Total revenue) * 100
= (2, 09, 300 / 10, 26, 000)* 100
= 13.7%
Total assets turnover = total revenue / total assets
= 10, 26, 000 / 15, 45, 300
= 0.66 or 66.39%
Financial leverage = total assets / Shareholders equity
= 15, 45, 300 / 4, 00, 000
= 3.86
Return on equity = net profit margin*asset turnover*financial leverage
= 0.33
Company ABC:
Net Profit Margin = (Net income / Total revenue) * 100
= (1, 36, 052 / 18, 23, 000)* 100
= 7.46% or 0.0746
Total assets turnover = total revenue / total assets
= 18, 23, 000 / 32, 85, 000
= 0.55 or 55.49%
Financial leverage = total assets / Shareholders equity
= 32, 85, 000/ 3, 20, 000
= 10.26
Return on Equity = net profit margin*asset turnover*financial leverage
= 0.41
The return on equity of ABC Company is more than PQR Company. But Net profit margin and Asset turnover of PQR Company is more than ABC Company. If Company PQR decreases its equity capital then the ROE is more than company ABC.
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