DuPont System

For Financial
Analysis
By Kevin Bernhardt, UW-Platteville and UW-
Extension
March 10, 2010
http://cdp.wisc.edu/Management.htm

First,
This Thing
Called Debt
Anatomy of Returns
Total Assets = Total Liabilities + Total Equity
Total amount of stuff
used in the business to
make profits (supplies,
inputs breeding stock,
machinery, etc.)
How much of
that stuff is
financed by the
bank, that is,
debt capital.
How much of
that stuff is
financed by
your own
money, that is,
equity capital.
So, when you make profits, those profits are a return to
all the assets, some of which is a return to your money
invested (equity capital) and some of which is a return
to the banks money (debt capital).
Anatomy of Returns Case 1
$1,000 of Total Assets (all financed by my own
money) generated $500 of total revenue, $400
of total expenses, and thus $100 of profits.
100
1000
=
$10 cents of
income per dollar
of asset
ROROA = 10%
Since it is all my money, then ROROE = 10%
Anatomy of Returns Case 2
$1,000 of Total Assets (financed $700 by my
own money and $300 @8% borrowed from a
bank) generated $500 of total revenue, $400
of expenses before interest for $100 profit,
and $76 profits after interest expenses.
$700
76
700
=
$300
My money
(Equity Capital)
Banks money
(Debt capital)
100
1000
=
$10.9 cents of income
per dollar of your
money
Before interest $.10 cents
of income per dollar of all
assets used.
Total Assets
$1000
ROROA = 10%
ROROE = 10.9%
ROROA>i-rate The extra is payment to equity
10% 8% Thus 2% additional to Equity
I leveraged someone elses money
to increase the return to my money.
Anatomy of Returns Case 2
$1,000 of Total Assets (financed $700 by my
own money and $300 @8% borrowed from a
bank) generated $500 of total revenue, $400
of expenses before interest for $100 profit,
and $76 profits after interest expenses.
ROROA>i-rate Thus ROROE>ROROA (thats good)
Return on equity capital 10% * $700 $70
Return on debt capital (10%-8%) * $300 $6
Total return $76
$76/$700 = 10.9% ROROE
DuPont System
Developed in 1919 by a finance executive at E.I.
du Pont de Nemours and Co
The DuPont system is a way of visualizing the
information so that everyone can see it.
(Stephen Jablonsky, Penn State University)
DuPont analysis is a good tool for getting
people started in understanding how they can
have an impact on results (Doug McCallen,
Caterpillar Inc.)
Number one, its simple (Sam Siegel, CFO)
DuPont System
DuPont Financial Analysis Model is a
rather straightforward method for
assessing the factors that influence a
firms financial performance. (Gunderson,
Detre, and Boehlje, AgriMarketing 2005)
DuPont System What is It?
The system identifies profitability as
being impacted by three different levers:

1. Earnings & efficiency in earnings
2. Ability of your assets to be turned into profits
3. Financial leverage
Earnings
Turnings
Leverage
Operating
Profit Margin
Asset
Turnover
Return On
Assets (less
interest adj.)
Financial
Structure
Return On
Equity
X =
X =
Income
Stream
Investment
Stream
Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
Operating
Profit Margin
Asset
Turnover
Return On
Assets (less
interest adj.)
Financial
Structure
Return On
Equity
X =
X =
Income
Stream
Investment
Stream
Earnings
Turnings
Leverage
DuPont System Ratios
Lets Do The Math
Operating
Profit Margin
Asset
Turnover
Return On
Assets (less
interest adj.)
Financial
Structure
Return On
Equity
X =
X =
Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
NFIFO + interest paid - unpaid labor/mgt
ROROA =
Total Assets
NFIFO + interest pd unpaid labor/mgt
Total Revenue
Total Revenue
Total Assets
Rate Of Return On Assets
Operating Profit Margin Ratio Asset Turnover Ratio
X
Operating
Profit Margin
Asset
Turnover
Return On
Assets (less
interest adj.)
Financial
Structure
Return On
Equity
X =
X =
Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
NFIFO unpaid labor/mgt
ROROE =
Total Equity
NFIFO + interest pd. unpaid labor/mgt
Total Assets
Total Assets
Total Equity
Rate Of Return On Equity
Rate Of Return On Assets
Leverage Ratio
-
interest pd.
Total Assets
i-rate Adj.
=
NFIFO unpaid labor/mgt
Total Assets
X
Net Farm Income From Operations
(NFIFO)
NFIFO = Total Revenue Basic Costs Non Basic Costs
sales, govt. pmts,
custom work +(-)
inventory changes
cash expenses
+(-) accrual expense changes
labor
+ depreciation
+ interest expenses
NFIFO = Total Revenue COGS Operating Expenses Interest
Return On
Assets
Total Assets
Total Equity
Return On
Equity
X =
Leverage
Leverage is the mix of debt
versus equity capital used in
making profits.

- Do we have too much debt?
- Do we have enough debt?
- Is our debt capital generating
profits?
- Can our debt capital be put to
better use?
OK
Too Low
Too Low
NFIFO unpaid labor/mgt + interest
Total Revenue
Total Revenue
Total Assets
Return On
Assets
Total Assets
Total Equity
Return On
Equity
X =
X =
Earnings
Turnings
Leverage
cash income +(-) inventory changes
cash expenses +(-) accrual exp changes + purch lstk Depr
labor + depreciation + interest expenses
OK
Too Low
OPMR
ATO OK
Too Low
Total Revenue =
Basic Costs =
Non Basic Costs =
OK
Too Low
-Too much labor given output
- Not enough labor
-Training and Education
- Better systems and processes
- Weekly/Daily staff meetings
- Performance metrics
NFIFO unpaid labor/mgt + interest
Total Revenue
Total Revenue
Total Assets
Return On
Assets
Total Assets
Total Equity
Return On
Equity
X =
X =
Earnings
Turnings
Leverage
OPMR
ATO
Too Low
OK
Too Low
OK
Too Low
-Unproductive machinery?
- Buildings not being used?
- Breeding livestock not producing?
- Unproductive land?
- Over valued assets?
Also, selling off unproductive assets
and paying off debt could change
your leverage position in a positive
way, and also improve your ROROE!
Financial Diagnostics via DuPont.
Finding the Red Flags!
ROROE
too Low
ROROA
too Low
Revenues too
low for costs
Unused or
Under
Utilized
Assets
Obsolete or
Inefficient
Assets
Leverage
Wrong Kind of
Debt
Not Enough
Debt
OPM too
Low
ATO too
Low
Costs too high
for Revenues
Prices
Production
Quality
Facilities
Processes
Operations
Health
Labor
Repairs
Timeliness
Management
Ability to
Manage
Assets
End
http://cdp.wisc.edu/Management.htm