Question

How does the DuPont equation/formula assist with analizing the return on equity ratio?

Answer 1

Du Pont equation/formula is used to analyse the different drivers of return on equity (ROE).
There are three metrics which is used to drive return on equity. First is operating effeciency,
assets use efficiency, and financial leverage.
DuPont Analysis formula is = Net Profit Margin x Assets Turnover x Equity Multiplier
Here, Net profit Margin = Net Profit/Turnover *100
Assets Turnover Ratio= Turnover/Average total Assets
Equity Multiplier= Average total assets/Average Shareholder's Equity
DuPont analysis breaks all three components of ROE in this way to clearly explain and
understand that which factor (Profit margin or Assets turnover or Equity multiplier) are
play the highest contribution for changing in ROE.
Normally ROE is itself provide return to equity holders but using DuPont model knowing
the fact of whether profit, utilisation of assets or leverage change return on equity effectively and
what does not impacted. So accoedingly DuPont analyse the return on equity with best manner.