How to analyze financial statements with the DuPont formula


DuPont analysis (also called the DuPont identity, DuPont formula , DuPont Model or the DuPont method) was discovered by the DuPont Company ca. 1920. Analysts of corporate finance use the formula for return on equity (ROE) but amends it to investigate other aspects of a company’s performance.

Return on Equity is calculated as Net income divided by Total Equity. The result of this calculation does not change if we multiply it by the quotient of assets divided by assets (which is 1). Having done this you can easily rewrite the ROE formula as (Net income/ Assets) * (Assets/Total Equity). Net income divided by Assets however is the formula for calculating the return on assets and Assets divided by Total Equity is recognized as the Equity Mulitplyer.

Continuing to rewrite this ROE formula [remember it was eventually (Net income/ Assets) * (Assets/Total Equity)] we multiply it by Sales/Sales and rearrange everything as follows: Return on Equity is: (Net Income / Sales) * (Sales/Assets) * (Assets/Total Equity). (Net Income / Sales) is the Profit Margin, (Sales / Assets) is total asset turnover and (Assets / Total Equity) is the Equity multiplier.

These kind of mathematical shenanigans show us that return on equity is influenced by three things:

1. The profit margin, which is a measure of operating efficiency 2. Total asset turnover which measures how efficiently we make use of our assets

3. The equity multiplyer which tells us how leveraged the company is.