Du Pont System of Analysis

Introduction:

For a thorough analysis of the company’s profitability, the leadership at DuPont

Corporation created a model known as DuPont Analysis in the 1920s. A method
called DuPont Analysis could aid us in avoiding drawing incorrect inferences about a
company’s profitability.

DuPont analysis is a financial ratio used to analyze a company’s overall performance.

The DuPont equation breaks down return on equity (ROE) into three separate
components. These are profit margin, asset turnover, and leverage. This analysis can
be helpful in identifying a company’s strengths and weaknesses. It also highlights
potential areas of improvement. DuPont analysis is named after the DuPont
Corporation, which popularized the use of this ratio in the early 20th century. In this
blog, we’re going to break down the DuPont equation and show you how to calculate
it. We’ll also provide some examples of how to use this ratio in real-world situations.

Du Pont Analysis Formula:

The DuPont system of analysis uses the following formula to decompose return on
equity (ROE) into its three components:

ROE = Profit Margin × Asset Turnover × Equity Multiplier

1. Profit Margin:
This component measures a company's ability to generate profits from its
revenues. The formula for profit margin is:

Formula
Profit Margin = Net Income / Revenue

This ratio indicates the percentage of revenue that translates into net income
after accounting for all expenses. A higher profit margin indicates better
profitability.
 2. Asset Turnover:
Asset turnover evaluates how efficiently a company utilizes its assets to
generate sales. The formula for asset turnover is:

Formula
Asset Turnover = Revenue / Average Total Assets

This ratio measures the amount of revenue generated for each unit of assets
employed. A higher asset turnover ratio suggests more efficient asset utilization.

3. Equity Multiplier:
The equity multiplier assesses the extent to which a company relies on debt
financing to support its operations and investment activities. The formula for the
equity multiplier is:

Formula
Equity Multiplier = Average Total Assets / Average Total Equity

This ratio indicates the proportion of total assets financed by equity compared
to debt. A higher equity multiplier suggests higher leverage or reliance on debt
financing.

Multiplying these three components together yields the return on equity

(ROE), which represents the overall profitability and efficiency of a company in
generating returns for its shareholders. By breaking down ROE into these
constituent parts, the Du Pont system allows analysts and investors to identify the
specific drivers of a company's performance and assess its financial health more
comprehensively.
Financial Statements of Nestle
 Financial Statements of Unilever

Statement of Profit or Loss

2021 2020 2019

Sales - net 19,820,946 15,572,747 13,291,424

Cost of sales -10,904,750 -8,894,178 -7,861,105

Gross profit 8,916,196 6,678,569 5,430,319

Distribution cost -2,888,333 -2,274,181 -2,270,003

Administrative expenses -486,020 -450,428 -343,712

Other operating expenses -371,223 -285,906 -178,067

Other income 331,367 428,421 304,339

Operating profit 5,501,987 4,096,475 2,942,876

Finance costs -79,151 -41,517 -135,076

Profit before taxation 5,422,836 4,054,958 2,807,800

Taxation -253,359 -217,546 -354,862

Profit after taxation 5,169,477 3,837,412 2,452,938

 Statement of Financial Position
2021 2020 2019
ASSETS
Non-current assets
Property, plant and equipment 4,053,993 3,732,128 3,654,460
Right-of-use asset 46,511 12,571 18,594
Intangible assets 81,637 81,637 81,637
Long term deposits 2,980 2,980 2,980
Long term loans and advances 1,144 3,371 5,157
4,186,265 3,832,687 3,762,828
Current assets
Stores and spares 196,537 164,302 140,520
Stock-in-trade 1,327,888 999,124 902,351
Trade debts - net 519,372 455,214 868,282
Loans and advances 3,531 69,256 13,854
Trade deposits and short term prepayments 82,055 77,395 14,408
Other receivables 96,045 57,506 32,050
Sales tax refundable - net 142,810 213,195 203,749
Taxation - net 536,557 648,799 426,235
Cash and bank balances 3,297,755 929,895 724,556
6,202,550 3,614,686 3,326,005
Total assets 10,388,815 7,447,373 7,088,833

EQUITY AND LIABILITIES

Share capital and reserves
Share capital 63,699 63,699 63,699
Reserves 2,905,867 2,683,995 2,240,498
Total equity 2,969,566 2,747,694 2,304,197

LIABILITIES
Non-current liabilities
Staff retirement benefits 15,513 25,727 24,141
Long term borrowings 168,619 23,660
Deferred income - government grant 29,271
Lease liabilities 20,571 387
Deferred taxation 357,704 361,050 280,539
591,678 410,824 304,680
Current liabilities
Trade and other payables 5,257,887 4,112,349 4,263,527
Current portion of deferred income -
2,252
government grant
Current portion of lease liabilities 387 11,519 30,392
Provisions 124,524 107,740 67,251
Unpaid dividend 1,416,018 31,180 27,348
Unclaimed dividend 24,627 25,447 21,504
Accrued interest / mark up 1,876 620 34,717
6,827,571 4,288,855 4,479,956
Total liabilities 7,419,249 4,699,679 4,784,636
Total equity and liabilities 10,388,815 7,447,373 7,088,833
 Du Pont Analysis Calculation
Formula:
The DuPont equation can be written as follows:

ROE = (profit Margin) × (Assets Turnover) × (Equity Multiplier)

Profit Margin = Net income

Sale

Assets Turnover = sales

Average total Assets

Equity Multiplier = Average total Assets

Average shareholders’ equity

Calculation:
Nestle:
ROE = (profit Margin) × (Assets Turnover) × (Equity Multiplier)

ROE= 0.09 × 2.11 × 13.16

ROE= 2.499

Unilever:
ROE = (profit Margin) × (Assets Turnover) × (Equity Multiplier)

ROE = 0.26× 2.22 × 3.12

ROE= 1.80
a) Profit Margin:
Profit Margin = Net income
Sale

Nestle Unilever
12768101 = 0.09 5169477 =0.26
133295472 19820946

b) Assets Turnover
Assets Turnover = Sales
Average Total Assets

Nestle Unilever
133295472 = 2.11 19820946 = 2.22
63155131.5 8918094

Average Total Assets:

Nestle Unilever
65403898 + 60906365 = 63155131.5 10388815 + 7447373 = 8918094
2 2

c) Equity Multiplier
Equity Multiplier = Average total Assets
Average shareholders’ equity

Nestle Unilever
63155131.5 = 13.16 8918094 = 3.12
4796857 2858630
Average shareholder’s Equity:

Nestle Unilever
5403272+4190442 = 4796857 2969566 + 2747694 = 2858630
2 2

Interpretation:
 Profit Margin (PM): Nestle has a lower profit margin (0.09) compared to
Unilever (0.26), which means Nestle retains less profit from each dollar of sales.

 Asset Turnover (AT): Nestle has an asset turnover of 2.11, meaning it generates
$2.11 in revenue for every dollar of assets, while Unilever has an asset turnover
of 2.22, indicating better efficiency in asset utilization.

 Equity Multiplier (EM): Nestle has a higher equity multiplier (13.16)

compared to Unilever (3.12), indicating Nestle relies more on debt financing
relative to equity.

 Overall, Nestle's higher ROE can be attributed to its strong asset turnover and
significant financial leverage, despite its lower profit margin. Unilever, on the
other hand, has a higher profit margin but lower asset turnover and financial
leverage, leading to a lower ROE compared to Nestle.