Can you provide an example of how DuPont Analysis is applied to financial statements?

Certainly! Let's walk through a simplified example of how DuPont Analysis can be applied to financial statements. For this example, we'll use three main financial ratios: Net Profit Margin (NPM), Asset Turnover (AT), and Equity Multiplier (EM). We'll then combine these ratios to calculate the Return on Equity (ROE) using the DuPont formula.

Financial Statements:

Let's consider a hypothetical company, ABC Inc., with the following financial information:

Income Statement:

• Revenue: $1,000,000
• Operating Expenses: $700,000
• Net Income: $200,000

Balance Sheet:

• Beginning Total Assets: $800,000
• Ending Total Assets: $1,000,000
• Beginning Shareholders' Equity: $400,000
• Ending Shareholders' Equity: $500,000

DuPont Analysis Calculation:

1. Net Profit Margin (NPM):

$NPM = \frac{Net\;Income}{Revenue}$

$NPM = \frac{200,000}{1,000,000} = 0.20$

2. Asset Turnover (AT):

$AT = \frac{Revenue}{Average\;Total\;Assets}$$\text{Average Total Assets} = \frac{Beginning\;Total\;Assets + Ending\;Total\;Assets}{2}$

$\text{Average Total Assets} = \frac{800,000 + 1,000,000}{2} = 900,000$

$AT = \frac{1,000,000}{900,000} \approx 1.11$

3. Equity Multiplier (EM):

$EM = \frac{Average\;Total\;Assets}{Average\;Shareholders'\;Equity}$

$EM = \frac{900,000}{\frac{400,000 + 500,000}{2}} \approx 2.25$

4. Return on Equity (ROE) - DuPont Formula:

$ROE = NPM \times AT \times EM$

$ROE = 0.20 \times 1.11 \times 2.25 \approx 0.50$

Interpretation:

In this example:

• Net Profit Margin (NPM) of 0.20 suggests that 20% of the company's revenue translates into net profit.
• Asset Turnover (AT) of approximately 1.11 indicates that the company generates $1.11 in revenue for every dollar of average total assets.
• Equity Multiplier (EM) of about 2.25 highlights the company's reliance on financial leverage.

The DuPont Analysis results in a Return on Equity (ROE) of approximately 50%, reflecting the overall performance of the company in terms of profitability, asset utilization, and leverage.

This breakdown allows analysts, investors, and management to understand not only the overall ROE but also the specific factors contributing to it. Changes in any of the individual ratios can be further investigated to identify areas for improvement or potential concerns.

Revenue: $100 million
Net income: $10 million

Total assets: $50 million
Shareholders' equity: $25 million