Question

Assess the purpose of using the DuPont system for analysis. Explain how the factors in the DuPont equation influence the ROA equation.

Answer 1

ROE using Dupont ratio gives information about  profitability, operating efficiency and the capital structure of the firm. It helps in identifying which portion contributes least or most contributes to ROE. This also helps in identify the weakness and helps in improving of the ratios in which the company is under performing. Return on equity is useful to investors who want return on their investment. Net profit margin is useful for both equity holders and debt holders. Asset turnover ratios is useful for equity holders . Equity multiplier is useful for debt holders because higher equity multiplier indicates higher leverage. Hence they possess higher risk.

. ROA = Net profit Margin* Asset Turnover
Net Profit Margin = Net Income/Sales
Assets Turnover = Sales/Total Assets
Net Profit Margin and Total Assets turnover are part of ROA. Higher the net profit margin and total assets turnover higher the ROA. Lower the ratios lower the ROA.. ROA can be analysed using net profit margin which provides information on profitability and total Assets turnover which provides information on operational efficiency.