1. The DuPont System was developed by DuPont Corporation to dissect a firm’s financial statement, so as to assess its financial condition.
2. It merges the Income Statement and Balance Sheet into two summary measures of profitability: Return On Total Assets (ROA) and Return On Equity (ROE). The top portion focuses on Income Statement & bottom on balance sheet.
3. Its allow us to break ROE into 3 components:
· as a Profit on Sales,
· as an efficiency of asset-use, and
· finally on use-of-leverage
By breaking it into 3 components, we can obtain a very detailed analysis of the financial health of the company.
1.0 By analysing the profitability and then with the total assets turnover on the efficiency of asset-use, we can get a Return on Total Assets (ROA).
· ROA = Net Income after Tax/Sales(a) X Sales/Total Assets (Assets Turnover)(b)
(a) denotes the profit margin whilst
(b) denotes how well management use the total assets of the company in terms of number of times the assets turn around in term of the sales
2.0 An added element or component is the Financial Leverage Multiplier. The Financial Leverage Multiplier (FLM) is the ratio of Total Assets to Shareholders’ Equity namely the degree of reliance on financing from borrowing and bonds.
The FLM transforms ROA into Return On Equity (ROE), which is ROA X FLM = ROE.
3.0 If we look at ROE alone (net income / owners’ equity), it doesn’t say much about how well a company uses its financing from borrowing and bonds.
However, if were to look at ROA (net income/ total assets financed by both debt and equity), this can help us to see how well a company puts both these forms of financing to use.