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The basic DuPont Analysis breaks the Return on Equity (ROE) down into 3 parts in an attempt to explain how the return was generated. ROE measures the return a company generate on the equity capital of the shareholders. One would break ROE down into different component to understand how ROE generated in the period being investigated, compare it to past periods or for camparison with competitors. To fully understand the possible uses of this simple analysis it is best to show you how the formula is derive. This will aid you in understand all financial models/ratios beter and enble you to create your own eqautions.
Step 1 ROE
ROE is Net Income divided by Average Shareholders Equity. Average shareholders equity is the begining of the year plus the end of the year divided by 2, this average out the formule to prevent large inflows or outflows to impact on the calculation.
| ROE |
= |
Net Income
Average Shareholders Equity
|
Step 2 ROE = ROA X LEVERAGE
Basic algebra tells us that any number times ONE (1) does not change in value. Further we know that any number divided by it's self equals ONE (1). We are simply going to multiply ROE equation in Step 1 with Average Total Assets divided by Average Total Assest. Think of it as the Step 1 eqaution times ONE.
Traditional DuPont Equation
| ROE |
= |
Nett Income
Sales |
X |
Sales
Assets
|
X |
Assets
Equity
|
ROE
|
=
|
Net Profit Margin
|
X |
Asset Turnover |
X
|
Leverage |
The expanded Du Pont Analysis
Extended DuPont Equation
| ROE |
= |
Net Income
EBT
|
X
|
EBT
EBIT
|
X
|
EBIT
Revenue
|
X
|
Revenue
Average Total Assets
|
X
|
Average Total Assets
Average Equity
|
|
