Question

Assess the purpose of using the DuPont system for analysis. Explain how the factors in the DuPont equation influence the ROA equation.

Answer 1

Du pont analysis
Purpose:	Du pont analysis is used to analyse the component / source of return of equity into three parts i.e profit margin, total asset turnover and leverage factor( financial leverage measured by equity multiplier) . It help investors and financial analysts to determine if a company is generting a return on shareholders equity then what is the actual source of that return i.e whether it is generating due to increase in profit margin or due to asset turnover or due to leverage factor. Means how the company generate return on equity. Here Return on equity=Net income/ Shareholder's equity.
	Where,Return of equity= (Net income/ Total sales)*( Total sales/ Total assets)*( Total Assets/ Shareholders Equity).
	Return of equity= (Profit Margin)*(Total asset Turnover)*( 1/ Shareholders Equity/Total Assets).
	Return of equity= (Profit Margin)*(Total asset Turnover)*( 1/ [Total assets- Total Debt]/[Total Assets]).
	Return of equity= (Profit Margin)*(Total asset Turnover)*( 1/ [1- [Total Debt]/[Total Assets]).
	Now breaking the return on equity helps to know profitability of company through profit margin ratio,efficiency in utilizing the assets of company through asset turnover ratio and level of leverage a company has through leverage factor
Return on Asset	=Net Income/ Average total assets
	Dupont analysis helps to break this return on assets into profitability ratio and asset turnover and helps to understand the source of return on assets via profit margin of company and efficiency in utilitizing the assets of the company.
Return on Asset( Basis Dupont)	=(Net Income/ Total Sales)* ( Total sales/ Average total assets)
	= Profit Margin* Asset Turnover ratio