In other words, the model describes that a company may become more efficient in terms of return on equity by ensuring high-profit margin, Increase Asset Turnover (by deploying asset efficiently), and by leveraging assets more effectively. It was developed by DuPont Corporation in the 1920s.
There are two versions of formula for DuPont Analysis:
= Profit Margin * Total Asset Turnover * Financial Leverage or,
= Net Income / Net Sale * Sales / Total Assets * Total Assets / Total Equity
Company X and Y are from same industry with the same size and have 20% return on equity. The respective profit margin, asset turnover, and financial leverage are mention below:
Profit margin = 8%
Asset Turnover = 1
Financial Leverage = 1.5
Profit margin = 9%
Asset Turnover = 1.3
Financial Leverage = 1.1
Although return on equity of both companies is same, however, the company Y is utilizing its assets more efficiently than the company X but it is unable to increase return on equity due to low financial leverage. So the company X can make improvements by utilizing assets more efficiently whereas the company Y may have increased return on equity by raising more debt.
The DuPont Analysis shows the true picture of business performance, it highlights the strength and weak areas. For example, if the return on equity is low then the model can be used to identify the problem by highlighting either there is a low-profit margin, assets are not being used efficiently or poor financial leverage.