DuPont Identity
What Is the DuPont Identity?
The DuPont identity is an articulation that shows a company's return on equity (ROE) can be addressed as a product of three different ratios: the profit margin, the total asset turnover, and the equity multiplier.
Figuring out the DuPont Identity
The DuPont identity, usually known as DuPont analysis, comes from the DuPont Corporation, which started involving the thought during the 1920s. DuPont identity lets us know that ROE is impacted by three things:
Operating efficiency, which is estimated by profit margin;
Asset use efficiency, which is estimated by total asset turnover; and
Financial leverage, which is estimated by the equity multiplier.
The formula for the DuPont identity is:
ROE = profit margin x asset turnover x equity multiplier
This formula, thusly, can be broken down further to:
ROE = (net income/sales) x (revenue/total assets) x (total assets/shareholder equity)
Assuming the ROE is unsuitable, the DuPont identity assists analysts and management with finding the part of the business that is failing to meet expectations.
DuPont Identity Example Calculation
Expect a company reports the accompanying financial data for a long time:
Year one net income = $180,000
Year one revenues = $300,000
Year one total assets = $500,000
Year one shareholder equity = $900,000
Year two net income = $170,000
Year two revenues = $327,000
Year two total assets = $545,000
Year two shareholder equity = $980,000
Utilizing the DuPont identity, the ROE for every year is:
ROE year one = ($180,000/$300,000) x ($300,000/$500,000) x ($500,000/$900,000) = 20%
ROE year two = ($170,000/$327,000) x ($327,000/$545,000) x ($545,000/$980,000) = 17%
With a small amount of rounding, the over two ROE computations break down to:
ROE year one = 60% x 60% x 56% = 20%
ROE year two = 52% x 60% x 56% = 17%
You can plainly see that the ROE declined in year two. During the year, net income, revenues, total assets, and shareholder equity all different in value. By utilizing the DuPont identity, analysts or managers can break down the reason for this decline. Here they see the equity various and total asset turnover remained precisely consistent over year two. This leaves just the profit margin as the reason for the lower ROE. Seeing that the profit margin dropped from 60 percent to 52 percent, while revenues really increased in year two, demonstrates that there are issues with the manner in which the company took care of its expenses and costs over time. Managers can then utilize these bits of knowledge to work on the next year.
