Question

How would you evaluate a company performance relative to its industry using dupoint method of analyzing performance:

when the company has a low net profit margin and a high total asset turnover and high debt to equity ratio compare to the industry?

Answer 1

The du-pont method of analyzing performance derives from the formula (NP ratio X Asset turnover X Equity multiplier).

As the company is having a low net profit margin shows that the company has to incurred high fixed expenses as compared to other companies of the industry.

On the other hand, as the company is enjoying high total asset turnover ratio which tells us the efficiency of the company to use its assets to create higher level of turnover/sales.

The high debt to equity ratio, also says that equity content in the total assets is very low, ie. Equity multiplier is low as compare to industry. So, the company is using the leverage to benefit the existing shareholders holding equity. But the debt is being served with high interest cost, which is reducing the net income instead of appreciating their wealth.

Thus, the conclusion of the analysis is that

“The company is well efficient in raising turnover by using its assets, but have to incur high fixed expenses and having high interest debt in the capital structure.”

To improve the company’s position following steps should be taken:

1) Convert the debt into equity and reduce interest expenses.

2) Controlling the fixed and overhead expenses.

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