DuPont Analysis: Definition, Formulas, and Examples
DuPont analysis includes multiple component ratios that combine to form the company’s return on equity (ROE) figure.
What is DuPont Analysis?
DuPont analysis includes multiple component ratios that combine to form the company’s return on equity (ROE) figure. There is a 3-step method and a 5-step method to calculating ROE using DuPont analysis. ROE evaluates how much profit a company generates based on the equity capital that investors have supplied to the business. High ROE is a good sign that the company is effectively using its capital to generate earnings for its shareholders.
Why Use DuPont Analysis?
DuPont analysis is a tool that can be used in financial statement analysis. Financial statement analysis is important to a company’s long term financial success. There are three main stakeholders who have an interest in the results of financial statement analysis:
- Internal users
- Potential lenders
- Potential investors
Internal analysts provide the findings of financial statement analysis to management in order to review the outcomes of current policies, predict future revenues, and suggest changes to future policies. Potential lenders use the information provided by financial statement analysis to determine if the company is a credit risk. They want to know whether the company can pay back their loan according to the terms of a loan agreement. Potential investors are interested in the results of financial statement analysis because they want to know that they will be receiving an adequate return for the money they are investing.
The DuPont analysis model can be used by internal analysts, lenders, and investors alike. DuPont breaks down the individual components of the ROE, and it can provide greater insight into what is going well in a company. It can also provide insight into what challenges the company is facing and where managerial efforts need to be directed.
History of DuPont Analysis
The DuPont analysis model was developed by Donaldson Brown, an electrical engineer who worked at DuPont Corporation in the early 1900s. When DuPont Corporation bought substantial stock in General Motors a few years later, Brown used DuPont analysis to determine shareholder return and suggest improvements to its financial situation. The analysis and resulting changes were highly successful, and the DuPont model gained traction with many other major U.S. corporations. It was the prevailing financial analysis model in the U.S. until the 1970s.
3-Step DuPont Analysis
The 3-step DuPont analysis model is the simpler version. In the 3-step model, the ROE is broken down into three ratio components:
- Net Profit Margin
- Asset Turnover
- Financial Leverage Ratio
Net Profit Margin
The net profit margin calculates a company’s “bottom line” profitability after all expenses have been accounted for. The net profit margin is an operating efficiency ratio. It compares the company’s bottom line to its revenue to see how efficiently the company is turning revenue into profit by maximizing revenue and minimizing expenses.
Asset Turnover
Asset turnover calculates a company’s ability to generate revenue based on the dollar value of the assets it owns. It is an efficiency ratio because the ratio increases when a company is more efficient at generating revenue with a smaller dollar value of assets.
Financial Leverage Ratio
The financial leverage ratio analyzes a company’s capital structure– the proportion of its debt to equity. Specifically, the financial leverage ratio looks at the company’s assets in relation to its stockholders’ equity.
3-Step DuPont Analysis Formula
The formulas for these three components are:
- Net Profit Margin = Net Income / Revenue
- Asset Turnover = Revenue / Average Total Assets
- Financial Leverage Ratio = Average Total Assets / Average Shareholders’ Equity
Therefore, the DuPont Analysis formula can be combined to the following:
3-Step DuPont Analysis ROE = (Net Income / Revenue) x (Revenue / Average Total Assets) x (Average Total Assets / Average Shareholders’ Equity)
These three formulas can be consolidated to form one ROE formula:
Return on Equity (ROE) = Net Income / Average Shareholders’ Equity
5-Step DuPont Analysis
The 5-step DuPont model is the more complicated version. In the 5-step model, the ROE is broken down into five ratio components:
- Tax Burden
- Asset Turnover
- Financial Leverage Ratio
- Interest Burden
- Operating Margin
The 5-step ratio has two new components: tax burden and interest burden. Additionally, it uses the operating margin instead of the net profit margin. Here are the details of the additional components.
Tax Burden
The tax burden represents the proportion of profits that are retained after the company has paid its taxes.
Interest Burden
The interest burden represents the extent to which interest expense impacts a company’s profits.
Operating Margin
The operating margin calculates the operating profit– after deducting cost of goods sold (COGS) and operating expenses– that a company retains as a portion of its sales revenue.
5-Step DuPont Analysis Formula
The formulas for these five components are:
- Tax Burden = Net Income / Pre-Tax Income
- Asset Turnover = Revenue / Average Total Assets
- Financial Leverage Ratio = Average Total Assets / Average Shareholders’ Equity
- Interest Burden = Pre-Tax Income / Operating Income
- Operating Margin = Operating Income / Revenue
Therefore, the DuPont Analysis formula can be combined to the following:
5-Step DuPont Analysis ROE = (Net Income / Pre-Tax Income) x (Revenue / Average Total Assets) x (Average Total Assets / Average Shareholders’ Equity) x (Pre-Tax Income / Operating Income) x (Operating Income / Revenue)
These five formulas can be consolidated to form one ROE formula:
Return on Equity (ROE) = Net Income / Average Shareholders’ Equity
Real World DuPont Analysis Example
Walmart Inc. provided its Consolidated Statement of Income and Balance Sheet for the tax year ending January 31, 2023 in its 2023 Annual Report. Using the information from these two financial statements, we can calculate the 3-step and 5-step variations of the DuPont analysis.
3-Step DuPont Analysis Calculation
Net Profit Margin = $11,680 Million / $611,289 Million = .0191 or 1.91%
Where:
- Net Income = $11,680 Million
- Revenue = $611,289 Million
Asset Turnover = $611,289 Million / [($243,197 Million + $244,860 Million) / 2] = 2.505
Where:
- Revenue = $611,289 Million
- Average Total Assets = [($243,197 Million + $244,860 Million) / 2]
Financial Leverage Ratio = [($243,197 Million + $244,860 Million) / 2] / [($76,693 Million + $83,253 Million) / 2] = 3.0514
Where:
- Average Total Assets = [($243,197 Million + $244,860 Million) / 2]
- Average Shareholders’ Equity = [($76,693 Million + $83,253 Million) / 2]
The full length version of the 3-step DuPont analysis is:
ROE = .0191 x 2.505 x 3.0514 = .1460 or 14.60%
Where:
- Net Profit Margin = .0191
- Asset Turnover Ratio = 2.505
- Financial Leverage Ratio = 3.0514
Consolidated, the DuPont analysis ROE formula can be shortened to:
ROE = $11,680 Million / [($76,693 Million + $83,253 Million) / 2] = .1460 or 14.60%
Where:
- Net Income = $11,680 Million
- Average Shareholders’ Equity = [($76,693 Million + $83,253 Million) / 2]
5-Step DuPont Analysis Calculation
Tax Burden = $11,680 / $17,016 = 0.6864 or 68.64%
Where:
- Net Income = $11,680 Million
- Income Before Income Taxes = $17,016 Million
Asset Turnover = $611,289 Million / [($243,197 Million + $244,860 Million) / 2] = 2.505
Where:
- Revenue = $611,289 Million
- Average Total Assets = [($243,197 Million + $244,860 Million) / 2]
Financial Leverage Ratio = [($243,197 Million + $244,860 Million) / 2] / [($76,693 Million + $83,253 Million) / 2] = 3.0514
Where:
- Average Total Assets = [($243,197 Million + $244,860 Million) / 2]
- Average Shareholders’ Equity = [($76,693 Million + $83,253 Million) / 2]
Interest Burden = $17,016 Million / $20,428 Million = .8330 or 83.3%
Where:
- Income Before Income Taxes = $17,016 Million
- Operating Income = $20,428 Million
Operating Margin = $20,428 Million / $611,289 Million = .0334 = 3.34%
Where:
- Operating Income = $20,428 Million
- Revenue = $611,289
The full length version of the 5-step DuPont analysis is:
ROE = 0.6864 x 2.505 x 3.0514 x 0.8330 x 0.0334 = .1460 or 14.60%
Where:
- Tax Burden = 0.6864
- Asset Turnover Ratio = 2.505
- Financial Leverage Ratio = 3.0514
- Interest Burden = 0.8330
- Operating Margin = 0.0334
Consolidated, the DuPont analysis ROE formula can be shortened to:
ROE = $11,680 Million / [($76,693 Million + $83,253 Million) / 2] = .1460 or 14.60%
Where:
- Net Income = $11,680 Million
- Average Shareholders’ Equity = [($76,693 Million + $83,253 Million) / 2]
DuPont Analysis vs. Return on Equity
DuPont analysis breaks ROE down into smaller components– three or five steps. ROE is the resulting figure, but DuPont analysis provides the necessary breakdown as to how the company reached that ROE figure. It allows financial statement users to more specifically analyze the areas in which a company is doing well and highlights the areas it needs to work on.
DuPont Analysis Limitations
The main limitation of DuPont analysis is that it relies on financial statement data that can be manipulated to some degree based on accounting policies and management strategies. The financial information used to calculate ROE in DuPont analysis may be more or less accurate based on the quality of its inputs.
Additional Resources
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