DuPont analysis

Two companies can report the same return on equity for completely different reasons. One sells at fat margins; one turns its assets over quickly; one has simply borrowed a lot.

DuPont analysis multiplies three ratios together to rebuild ROE, so you can see which lever produced it — and, in a diagnostic study, which lever moved when ROE rose or fell. A rise driven by margin or efficiency is a reason to cheer. A rise driven by leverage, the workbook says, need not be, because higher leverage brings higher risk.

The three factors cancel back to ROE — sales and assets appear once on top and once below:

The workbook's own illustration (section 8.12):

HighLevCo looks far better on ROE. LowLevCo has the better margin and slightly better turnover; its lower ROE is entirely the absence of debt — which also means lower risk.

ROE = Net profit ÷ Equity
    = (Net profit ÷ Sales) × (Sales ÷ Assets) × (Assets ÷ Equity)
    = Net profit margin × Asset turnover × Equity multiplier

Illustrative figures, Rs crore. A consumer durables company over three years; total assets stay at Rs 1,000 crore throughout.

Check Year 1: 10% × 1.20 × 2.0 = 24%, and 120 ÷ 500 = 24%.

Year 2: ROE falls four points. Turnover actually improved; the whole fall is margin, from 10% to 8%.

Year 3: ROE jumps to a three-year high. Margin and turnover did not move. The company replaced Rs 100 crore of equity with debt, lifting the multiplier from 2.0 to 2.5. The headline says recovery; DuPont says the business is exactly as good as Year 2 and now carries more risk.

Chapter 8 (Company Analysis – Financial Analysis) lists "Computation of Dupont analysis" among its learning objectives and covers it in section 8.12 with the HighLevCo / LowLevCo example; the chapter's case study asks which factors favourably contributed to one company's higher ROE. Chapter 10 reinforces the point that leverage improves ROE but excessive leverage is risky.

• The third factor is Assets ÷ Equity, not Debt ÷ Equity. A company with no debt has an equity multiplier of 1.0, not zero.
• Higher ROE from leverage is not automatically good — the workbook's whole point with HighLevCo.
• Asset turnover here is Sales ÷ Total assets, the same efficiency ratio defined in section 8.11.5.
• The three factors must multiply back to ROE. If they do not, one ratio used a different denominator — check whether average or closing balances were mixed.
• The workbook recommends average equity for ROE generally, but its DuPont illustration uses single figures; use whatever the question supplies, consistently.