Question

. Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity

Answer 1

Du Pont Analysis decomposes Return on Equity into three parts and helps analyse which part contributes the most to the changes in Return on Equity (ROE).

In accounting terms, ROE= Net Income/ Shareholders' Equity

As per Du Pont analysis, ROE is broken down in the following way:

Net profit margin * Asset Turnover * Equity Multiplier

where, Net profit margin : Net income/ Sales; measures operating efficency

Asset Turnover: Sales/ Assets; measures asset use efficiency

Equity Multiplier; measures financial leverage

The ROA (return on assets) has been broken down by Du pont as a combined effect of profit margin and asset turnover. It measures at what level does a Firm effectively manage its assets to generate revenues and finally profits.

ROA= (Net income/ Revenue) * (Revenue/ Average total assets)= Net income/ Average total assets

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