The formula of DuPont - an example of calculation

The DuPont model is considered to be one of the effective methods for carrying out factor analysis. It was proposed in 1919 by specialists of the company of the same name. While time was widely distributed indicators of profitability of asset turnover and sales. It was in this model that these indicators were considered together for the first time, while the model had a triangular structure.

Dupont's formula is often used, and factor analysis with its help is extremely simple. At the top of the triangle is a coefficient indicating the profitability of the total capital, it is in this scheme the main indicator, which means profit from the funds invested in the company. Below are the factors of factor type, namely the size of the profit (profitability of sales) and asset turnover. DuPont's formula means that return on investment will be equal to the product of profits from sales and current assets.

DuPont's model

The main purpose of the Dupont model is to identify factors that can determine the effectiveness of the business, to assess the extent to which these factors influence the development trends, taking into account their change and significance. Basically, it is used to assess risks, and this applies to both the capital that is used to develop the organization and investing in other projects. Below, we consider the main parameters of the model.

Return on the company's capital

In order for owners to receive profitability from investment, they need to make contributions to the authorized capital. The calculations, which shows Dupont's formula, say that for this they have to sacrifice the funds that form the capital of the company, but at the same time they are entitled to a share of the profit they receive. It is advantageous for them to be displayed on their own capital, thus forming an important process for shareholders. But the application of this model entails the introduction of restrictions. Real income can only be obtained from sales, while assets do not bring profit. Based on this indicator, it is impossible to assess the business units of the company. It is also necessary to take into account the fact that companies basically have borrowed capital.

For the factor analysis, the DuPont formula plays an important role: an example, if considered a banking business, as a loan capital has the basis for building a business. This means that the actual operation of the bank is carried out at the expense of attracted deposits, and the role of equity capital is reserve savings, in other words, a guarantee that the bank is able to maintain its liquidity. That is, the indicator in question can only answer questions related to own capital, which the organization earns for auctioneers.

Revolving asset processes

The turnover of assets is the indicator that reflects the amount of capital turnover that is invested in the organization's assets over a certain period of time. In other words, it is an estimate of the intensity of exploitation of all assets, and there is no difference in the sources by which they originated. It is also able to show what the company's revenue is from the money invested in the assets.

Profitability of sales

If Dupont's formula is taken as the main factor of calculation, this indicator is used, as the main indicator, by means of which the efficiency of the organization is estimated, which does not have too great savings of own capital and fixed assets. In fact, if the value of the denominator is low during the calculations, it turns out that the company's financial potential is overstated by obtaining too high return on its own capital. With this approach, it is possible to objectively assess the current state of affairs of the company.

Also, through the indicator of profitability of sales, you can clearly see how much the company received net profit from the amount of the sold unit. If you use the Du Pont formula, this indicator allows you to calculate the amount of net income that the organization will have after covering the cost of the product, paying all taxes and interest on loans. With the help of this indicator, important aspects are revealed, namely the realization of products and the share of funds spent on obtaining them.

Return on assets. Dupont's formula

This indicator reflects the effectiveness of the company's operational activities. It is used as the main production indicator capable of displaying the efficiency of working with invested capital. Based on this, we note that the profitability of total assets can be determined by two factors - profit and turnover. Together, this creates a multiplicative model used in accounting reports.

Financial leverage

A financial lever is necessary in order to relate borrowed and equity capital, as well as to show its impact on the net profit of the enterprise. It is worth noting that the higher the proportion of loans, the lower the net profit, because the amount of interest costs will increase. If a company has a high percentage of loans, it is customary to call it dependent. Conversely, an organization that does not have borrowed capital is considered financially independent. Thus, the role of financial leverage is to determine the sustainability and riskiness of the business, and also as a tool for assessing the effectiveness of working with loans. It should be taken into account that the return on equity is directly dependent on the lever.

Dupont's model (formula):

ROE = NPM * TAT

The difference between the profitability of total assets and the cost of a loan is equal to the differential of the financial leverage.

The ratio of interest expenses to borrowed capital, including taxes, is equal to the cost of borrowed capital.

Given that the financial lever is able to increase the profitability of capital, it increases the shareholder value. This is evidenced by Du Pont's formula, an example of which is a financial lever. Thanks to this, it is possible to optimize the structure of assets. It is worth noting that additional capital increase should be carried out as long as the lever remains positive. And it will acquire a negative value, as soon as the cost of the loan exceeds the return on equity. Dupont's formula clearly reflects the significance of this indicator. It is also worth remembering about financial stability, if the number of debts exceeds the required threshold, the company is in for bankruptcy.

Borrowing limits

To denote this boundary, Dupont's formula shows that the difference between own capital and the size of illiquid, fixed assets should be positive. Taking into account the received values, it is possible to build an enterprise policy. For the profitability of sales - accounting price policy, control costs management, optimize sales volumes and much more.

Asset turnover will affect their management, credit policy and inventory management system. The capital structure will affect all spheres of investment and taxes.

General assessment

Return on equity is an indicator of the effectiveness of financial management. This value directly depends on the decisions made regarding the main areas of the company. If this indicator changes, then the efficiency of the business grows or falls. Through the return on assets, it is possible to track the efficiency of working with investment capital, since it is the link between the main and financial activities, as well as between sales and assets.

Effectiveness of management of core activities

To measure the effectiveness of management of core activities, the profitability of sales is used. This indicator can vary both under the influence of external factors, and taking into account the internal needs of the company.

As an example, consider the change in profitability taking into account various factors in more detail:

• Profitability of sales can increase taking into account that the rate of revenue will be faster than the rate of costs, this situation can arise if sales volume has increased or their range has changed. This is a positive development of the company.
• Costs decrease faster than revenue. This situation may arise in the event of an increase in product prices or a change in the structure of sales. In this case, the profitability index is growing, but the amount of revenue is decreasing, which, undoubtedly, will not have a very positive effect on the company's development.

• There is an increase in revenue and cost reduction, this situation can simulate higher prices, a change in the range or cost norms.
• Costs grow faster than revenue. The reason may be inflation, lower prices, higher costs, a change in the structure of sales. The situation is quite unfavorable, pricing analysis is necessary.
• Revenue declines faster than costs, which can only be affected by sales volume cuts. Here the analysis of marketing policy is important.