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The Dupont Financial Analysis System
 And Why It Is Important

Fundamentally, for any business there are two primary ways to enhance operating performance as measured by return on assets:

  • increase operating profit margins, and

  • increase gross revenues per dollar invested or capital turnover.

Operating performance can be augmented through the use of debt or leverage to generate the ultimate performance measure for the individual investor - return on investment equity. These are expressed in the Dupont equation as follows:

Return on Equity = Asset Turnover x Net Profit Margin x Leverage

Breaking ROE into these three parts allows evaluation of how well you are managing assets, expenses and debt. That is, a business manager has three general ways to improve operating performance in terms of ROA and ROE:

  • Increase capital asset turnover

  • Increase operating profit margins

  • Change financial leverage

The first two enhance both ROA and ROE, while a change in leverage only affects ROE because the interest expense is added back to net income in the ROA calculation.

Each of these primary levers or drivers are impacted by the specific decisions on cost control, efficiency and productivity, marketing choices etc. Therefore, this analysis format can capture the impact of almost any management decision that is made

return on assets ("ROA") = operating profit margin x asset turnover ratio

= (net income + interest income) / total assets

return on equity ("ROE") = (ROA - interest cost adjustment) x financial structure

= net income / equity

operating profit margin = (net income + interest income) / gross revenue

net income = gross revenues - fixed costs - variable costs

asset turnover ratio = gross revenue / average total assets

interest cost adjustment = interest costs / total assets

financial structure = total assets / equity ( the reciprocal of equity percentage)

The bolded definitions above are the heart of the Dupont financial analysis system. The short cut methods of calculating ROA and ROE accompany the Dupont equations as the unbolded equations, but they do not have the power the Dupont form has. The relationship between the three factors of operating profit margin, capital asset turnover ratio, and financial structure (a measure of financial leverage) and the basic concepts underlying the Dupont system can be summarized mathematically as follows:

Equation 1:

return on assets ("ROA") = operating profit margin x asset turnover ratio
This can be restated as follows:

ROA = 
(Net Income + Interest Expense / Gross Revenue)  X (Gross Revenue / Total Assets)

Equation 2:

return on equity ("ROE") = (ROA - interest cost adjustment) x financial structure
This can be restated as follows:

ROE = ((Net Income + Interest Expense) / Total Assets) - (Interest / Total Assets) X (Total Assets / Equity)

Why Dupont Financial Analysis is Important

Fundamentally, any decision that influences product prices, per unit costs, volume or efficiency / productivity (output per unit of input) will impact profit margin or turnover ratio.  And any decision that affects the amount and type of debt and equity used will impact the financial structure as well as cost.

These financial concepts are important to understand because every business in the world is competing for capital.  Money flows where the perceived risk adjusted return is greatest.  If we as marketers of products and services to businesses understand these financial concepts, we can better understand where we might be able to help our customers the most.  We need to understand how we deliver value to our business customers.

Marketing value involves much more than a pep rally/sales meeting rah-rah. It's a culture ... a mindset, a strategy. To do it well, you first need to be able to define it. Understanding the financial concepts allows you to focus on the key questions you should answer to help define your value. 

How do you or how can you help your customers:

  • Increase the price per unit of product they sell by adding new features and benefits to their products, services, and systems
  • Decrease the variable cost to produce, acquire or sell the unit.
  • Increase the number of units sold
  • Decrease the overhead by increasing their efficiency of operations
  • Increase asset turnover by
  • Minimizing the customer's work in process or finished goods inventory (and therefore total assets)
  •  Decreasing fixed assets by outsourcing some processes, enabling some capital assets to be sold

To truly add value and set yourself apart from the com petition, you need to know how to help your customers 

  • control one or more of their critical costs or 
  • exploit one or more of their critical revenue sources. 

Ask yourself these two key questions about what you sell, and your opportunities to add value to your customers will increase dramatically.