Du_pont
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Du Pont System of Analysis — Decomposition of ROE The decomposition of ROE into component ratios is generally referred to as the Du Pont System, after the Du Pont firm that analyzes it first. Thus, Du- Pont analysis on ROE has been carried out to derive factors contributing towards the profitability. A firm’s ROE is composed of three ratios as follows: The product of first two ratios on the right hand side—net profit margin and asset turnover —gives us a firm’s return on total assets (ROA).
description
about ratio analysis, ROE decomposition.
Transcript of Du_pont
Du Pont System of Analysis — Decomposition of ROE
The decomposition of ROE into component ratios is generally referred to as the Du Pont System, after the Du Pont firm that analyzes it first.
Thus, Du- Pont analysis on ROE has been carried out to derive factors contributing towards the profitability.
A firm’s ROE is composed of three ratios as follows:
The product of first two ratios on the right hand side—net profit margin and asset turnover—gives us a firm’s return on total assets (ROA).
The system highlights the fact that firms can increase ROA by increasing profit margins or asset turnover.
Of course, a high degree of competition limits their ability to do so simultaneously. Thus, firms tend to face a trade off between turnover and margins.
It is also often useful to describe financial strategies in terms of margins and turnover. Suppose a firm selling electronic equipment is thinking about providing customers with more liberal credit terms. This will probably decrease asset turnover because receivables would increase more than sales. Thus, the margins will have to go up to keep ROA from falling.
The third ratio of total assets to equity, equity multiplier, indicates the proportion of total assets financed with debt.
From the breakdown of ROE, it would appear that debt always magnifies return on equity and this occurs only when gross return on asset is greater than interest rate on debt.
Alternative Formulation of Du-pont (Five factor analysis)
Du Pont Analysis and its sensitivity
DU PONT ANALYSIS FOR SQUAREPeriod Net Margin Asset Utilization ROA Leverage ROE1996 0.1234 0.786 0.097 1.25 0.12121997 0.1337 0.845 0.113 1.23 0.13901998 0.1603 0.850 0.136 1.23 0.1676
"What if" AnalysisPeriod Net Margin Asset Utilization ROA Leverage ROE1996 0.1234 0.786 0.097 1.25 0.12121997 0.1234 0.845 0.104 1.23 0.12831998 0.1234 0.850 0.105 1.23 0.1290
Period Net Margin Asset Utilization ROA Leverage ROE1996 0.1234 0.786 0.097 1.25 0.12121997 0.1337 0.786 0.105 1.23 0.12931998 0.1603 0.786 0.126 1.23 0.1550
Period Net Margin Asset Utilization ROA Leverage ROE1996 0.1234 0.786 0.097 1.25 0.12121997 0.1337 0.845 0.113 1.25 0.14121998 0.1603 0.850 0.136 1.25 0.1703
