Du Pont analysis
|Du Pont analysis|
Du Pont Analysis is a comprehensive evaluation method based on the profitability presented in the pyramid of indicators. It allows to assess the financial situation in a synthetic way. It combines the data from the balance sheet and profit and loss account.
The Du Pont method has been used in financial analysis for the first time in 1919It was created by chief financial officer of Du Pont de Nemours and Co, which after World War I was developing very rapidly through acquisitions. By using this method, the company could choose the most attractive targets for acquisition.
In Du Pont pyramid major role play following indicators:
- Rate of return on equity (ROE),
- Rate of return on assets (ROA)
- Net profit margin
Through these three indicators it is possible to make comparisons of enterprises regardless of the type of activity. These comparisons help managers make strategic decisions about investment, production, capital allocation and ongoing services.
The most important indicator is the rate of return on equity (ROE):
'ROE = net profit / equity'
ROE is most important for shareholders, as they are interested on profit from capital contributed by them. It is a measure of the efficiency of capital invested in the enterprise. The ROE level is influenced by three factors:
- Operational efficiency (expressed as the profit margin),
- Efficiency of assets (expressed as total assets turnover),
- Financial leverage (expressed by the equity multiplier).
Du Pont analysis had a huge impact on the views of economists and still occupies an important place in the arsenal of methods to assess the financial health of the company.
- Liesz, T. J. (2002). Really modified Du Pont analysis: Five ways to improve return on equity.