The DuPont system of financial analysis combines the ratios and ratios of activity with those of return on sales, resulting in the way in which the two interact to determine the return on assets. This method is also known as Return on Total Assets and measures the efficiency of the company in taking advantage of the resources involved in it.
A part of the system develops the rotation of assets, showing the sum of the current assets, added to the fixed assets, giving the total assets of a company. This total invested divided by sales, results in the total investment turnover. It is equivalent to the turnover of Total Assets with respect to Sales.
The other part of the system shows the profit on sales after tax. Net profit divided by sales is the profit margin on sales. When asset turnover is multiplied by return on sales, it results in return on investment (ROI).
Mathematically it shows:
ROI = Net Sales / Total Investment x Net Profit / Net Sales
Graphical representation of the DuPont system of financial analysis. Source: Levy, p.104.
The DuPont system can incorporate the company's leverage, which is expressed as follows:
ROI / = Rate of Return on equity
This formula is useful to show how financial leverage can be used to increase the rate of return on equity. But using more unlimited financial leverage to increase the return on your own investment can be terribly risky as a result of excessive indebtedness, rising financial costs, and possible lack of ability to pay.
Through the following video-lesson, by Professor Gerardo Yañez, you will learn what the DuPont system model of financial analysis is and how it works to measure the profitability of the company and as a management tool.
Bibliography
Haime Levy, Luis. Financial planning in the modern company. ISEF, 2004, pp. 103-105.
