The Dupont model is considered one of the effective methods of factor analysis. It was proposed back in 1919 by specialists of the same name company. At that time, the indicators of return on assets and sales turnover were widely spread. It was in this model that these indicators were considered together for the first time, while the model had a triangular structure.
Often the Dupont formula is used, factor analysis with its help is extremely simple. At the top of the triangle is a coefficient indicating the profitability of total capital; it is the main indicator in this scheme, which means the profit from the funds invested in the company. Below are the indicators of the factor type, namely the size of the profit (return on sale) and asset turnover. Dupont formula means that the return on investment will be equal to the product of profit from sales and current assets.
Dupont Model
The main goal of the Dupont model is to identify factors that can determine business performance, to assess the degree of influence of these factors on development trends, taking into account their changes and significance.
Basically, it is used to assess risks, and this applies both to the capital that is used to develop the organization, and to invest in other projects. Below we consider the main indicators of the model.
Return on equity
In order for owners to be able to get profitability from investing, they need to make contributions to the authorized capital. The calculations shown by the Dupont formula indicate that for this they have to sacrifice funds that form the capital of the company, but at the same time they have the right to a share of the profit received by the organization. It is beneficial for them to display it on equity, thus forming an important process for shareholders. But the use of this model entails the introduction of restrictions. Real income can only be obtained from sales, while assets do not bring profit. Based on this indicator, it is impossible to assess the units of a company’s business. It is also worth considering the fact that companies mainly have borrowed capital.
For factor analysis, the Dupont formula plays a large role: an example, if we consider the banking business, has the basis for building a business as borrowed capital . This means that, in fact, the bank's operating activities are carried out at the expense of attracted deposits, and the role of equity is reserve savings, in other words, a guarantee that the bank is able to maintain its liquidity. That is, the indicator in question can only answer questions related to equity that the organization earns for auctioneers.
Asset turnover processes
Asset turnover is an indicator that displays the number of turns of capital that is invested in the assets of an organization over a certain period of time. In other words, it is an estimate of the intensity of exploitation of all assets, and there is no difference through which sources they were formed. He is also able to show what revenue the company has from cash invested in assets.
Return on sales
If the Dupont formula is taken as the main factor of the calculation, this indicator is used as the main indicator, with the help of which the effectiveness of an organization is evaluated, which does not have very large savings in equity and fixed assets. In fact, if the denominator is low during the calculations, it turns out that the financial potential of the company is overestimated by obtaining too high a return on equity. With this approach, it is possible to objectively assess the current state of affairs of the company.
Also, through the indicator of profitability of sales it is clearly visible how much the company received net profit from the amount of the sold unit of production. If the Dupont formula is used, this indicator allows you to calculate the amount of net income that the organization will have after it covers the cost of the product, will pay all taxes and interest on loans. Using this indicator, important aspects are identified, namely the sale of products and the share of funds spent on their receipt.
Return on assets. Dupont formula
This indicator reflects the effectiveness of the company's operations. It is used as the main production indicator that can reflect the efficiency of work with invested capital. Based on this, we note that the profitability of total assets can be determined by two factors - profit and turnover. Together, this creates the multiplicative model used in the financial statements.
Financial leverage
Financial leverage is necessary in order to correlate borrowed and own capital, as well as to show its influence on the net profit of the enterprise. It is worth noting that the higher the share of loans, the less will be the net profit, since the amount of interest costs will increase. If a company has a high percentage of loans, it is customary to call it dependent. Conversely, an organization that does not have borrowed capital is considered financially independent.
Thus, the role of financial leverage is to determine the sustainability and riskiness of the business, and also as a tool for assessing the effectiveness of working with loans. It should be borne in mind that the return on equity is directly dependent on leverage.
Dupont Model (formula):
ROE = NPM * TAT
The difference between the return on total assets and the cost of the loan is equal to the differential of financial leverage.
The ratio of interest to borrowed capital, including taxes, is equal to the cost of borrowed capital.
Given the fact that financial leverage is able to increase return on equity, it also increases shareholder value. This is evidenced by the Dupont formula, an example of which is represented by financial leverage. Due to this, it is possible to optimize the structure of assets. It is worth noting that an additional increase in capital should be carried out as long as the leverage remains positive. And it will acquire a negative value as soon as the cost of the loan exceeds the return on equity. The Dupont formula clearly reflects the significance of this indicator. It is also worth remembering about financial stability, if the number of debts exceeds the necessary threshold, the company will face bankruptcy.
Border for using loans
To indicate this boundary, Dupont's formula shows that the difference between equity and the value of illiquid, fixed assets should be positive. Based on the obtained values, you can build an enterprise policy. For the indicator of sales profitability - accounting for pricing policies, cost control, optimization of sales volumes and much more.
Asset turnover will affect their management, credit policy and inventory management system. The capital structure will affect all areas of investment and taxes.
General assessment
Return on equity is an indicator of the effectiveness of financial management. This value directly depends on the decisions made regarding the main areas of the company. If this indicator changes, then the business performance is increasing or falling. Through the return on assets, it is possible to track the effectiveness of working with investment capital, since it is the link between the main and financial activities, as well as between sales and assets.
Management Effectiveness
To assess the effectiveness of the management of core activities used indicator of return on sales. This indicator can change both under the influence of external factors, and taking into account the internal needs of the company.
As an example, consider the change in profitability, taking into account various factors in more detail:
- Profitability of sales may increase taking into account the fact that the rate of revenue will be faster than the rate of expenses, this situation may arise if the sales volume has increased or their assortment has changed. This is a positive development trend for the company.
- Costs decrease faster than revenue. This situation may arise in the event of an increase in product prices or a change in the structure of sales. In this case, the profitability indicator grows, but the revenue volume decreases, which, undoubtedly, will not have a very positive effect on the development of the company.
- There is an increase in revenue and a decrease in costs, this situation can be simulated by increased prices, a change in the range or cost standards.
- Costs grow faster than revenue. The reason may be inflation, lower prices, higher costs, changes in the sales structure. The situation is rather unfavorable, pricing analysis is needed.
- Revenues are reduced faster than costs; only sales reductions can affect this. The analysis of marketing policy is important here.