What is the DuPont Model?

Description
The DuPont Model is a technique that can be used to analyze the profitability
of a company using traditional performance management tools. To enable
this, the DuPont model integrates elements of the Income Statement with
those of the Balance Sheet.

Origin of the DuPont Model. History
The DuPont model of financial analysis was made by F. Donaldson Brown, an
electrical engineer who joined the giant chemical company's Treasury
department in 1914. A few years later, DuPont bought 23 percent of the
stock of General Motors Corp. and gave Brown the task of cleaning up the car
maker's tangled finances. This was perhaps the first large-scale reengineering
effort in the USA. Much of the credit for GM's ascension afterward belongs to
the planning and control systems of Brown, according to Alfred Sloan,
GM's former chairman. Ensuing success launched the DuPont model towards
prominence in all major U.S. corporations. It remained the dominant form of
financial analysis until the 1970s.

Calculation of DuPont. Formula
Return on Assets = Net Profit Margin x Total Assets Turnover = Net Operating
Profit After Taxes/ Sales x Sales/ Average Net Assets

Usage of the DuPont Framework. Applications
The model can be used by the purchasing department or by the sales
department to examine or demonstrate why a given ROA was earned.
Compare a firm with its colleagues.
Analyze changes over time.
Teach people a basic understanding how they can have an impact on the
company results.
Show the impact of professionalizing the purchasing function.

Steps in the DuPont Method. Process
Collect the business numbers (from the finance department).
Calculate (use a spreadsheet).
Draw conclusions.
If the conclusions seem unrealistic, check the numbers and recalculate.
Strengths of the DuPont Model. Benefits
Simplicity. A very good tool to teach people a basic understanding how they
can have an impact on results.
Can be easily linked to compensation schemes.
Can be used to convince management that certain steps have to be taken to
professionalize the purchasing or sales function. Sometimes it is better to
look into your own organization first. In stead of looking for company
takeovers in order to compensate lack of profitability by increasing turnover
PDF Created with deskPDF PDF Writer - Trial :: http://www.docudesk.com
and trying to achieve synergy.
Limitations of the DuPont analysis. Disadvantages
Based on accounting numbers, which are basically not reliable.
Does not include the Cost of Capital.
Garbage in, garbage out.
Assumptions of the DuPont method. Conditions
Accounting numbers are reliable.

Financial analysis with the DuPont ratio: A useful compass
In today's dynamic business environment, it is important for credit
professionals to be prepared to apply their skills both within and outside the
specific credit management function. Credit executives may be called upon to
provide insights regarding issues such as strategic financial planning,
measuring the success of a business strategy or determining the viability of
an acquisition candidate. Even so, the normal duties involved in credit
assessment and management call for the credit manager to be equipped to
conduct financial analysis in a rapid and meaningful way.

Financial statement analysis is employed for a variety of reasons. Outside
investors are seeking information as to the long run viability of a business
and its prospects for providing an adequate return in consideration of the
risks being taken. Creditors desire to know whether a potential borrower or
customer can service loans being made. Internal analysts and management
utilize financial statement analysis as a means to monitor the outcome of
policy decisions, predict future performance targets, develop investment
strategies, and assess capital needs. As the role of the credit manager is
expanded cross-functionally, he or she may be required to answer the call to
conduct financial statement analysis under any of these circumstances. The
DuPont ratio is a useful tool in providing both an overview and a focus for
such analysis.

A comprehensive financial statement analysis will provide insights as to a
firm's performance and/or standing in the areas of liquidity, leverage,
operating efficiency and profitability. A complete analysis will involve both
time series and cross-sectional perspectives. Time series analysis will
examine trends using the firm's own performance as a benchmark. Cross
sectional analysis will augment the process by using external performance
benchmarks for comparison purposes. Every meaningful analysis will begin
with a qualitative inquiry as to the strategy and policies of the subject
company, creating a context for the investigation. Next, goals and objectives
of the analysis will be established, providing a basis for interpreting the
results. The DuPont ratio can be used as a compass in this process by
directing the analyst toward significant areas of strength and weakness
evident in the financial statements.

PDF Created with deskPDF PDF Writer - Trial :: http://www.docudesk.com