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What is a DuPont analysis?

What is a DuPont analysis?

“DuPont analysis” refers to a formula that measures a company’s financial performance in terms of ROE or “return on equity.”  Its name comes from DuPont Corporation which is credited for creating and using the performance formula.

Based on the DuPont analysis formula, a company’s ROE performance is mainly affected by three variables including its efficiency in terms of operations, efficiency in the use of assets, and financial leverage.  The first variable is operational efficiency, and this can be measured by taking the profit figures and dividing it over the sales figures.  For smaller companies, this variable may be their only concern because it will give an idea if the company is able to support its operations with existing resources and resulting profits, if there are any.  Efficiency in asset use, meanwhile, can be measured through the total asset turnover figures. The third variable, which is financial leverage of the company, can be measured by dividing the total assets with the total equity figures.  All results of the three variables will be multiplied to get the ROE or return on equity result.

A good ROE value is something that investors in a particular company would expect and hope for.  Higher ROE values literally mean that a company is financially sound and stable, and, therefore, investing in it is a good move.  And as with all companies and businesses, one of the main goals is to please investors with a good financial performance through a high ROE.  Through the three variables involved in the DuPont analysis formula, possible investors can properly decide whether a company is really worth investing in or not.  The performance formula involved in a DuPont analysis is not applicable to all businesses and industries, though, since not all companies’ performance can accurately be judged by their operational efficiency alone or asset turnover and financial leverage, for example.  For industries that have different ways of using assets or leveraging, they must use other performance or ROE measures other than the DuPont analysis formula.

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Posted by Erwin Z on Feb 12th, 2013 and filed under Finance & Investing. You can follow any responses to this entry through the RSS 2.0. You can leave a response via following comment form or trackback to this entry from your site