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Subject :
Dupont Analysis
Return On Assets
Introduction :
It is easy to evaluate the performance of single product company because all assets and operations are identified with a single responsibility centre. A diversified Co. would like to assess the profitability of its different lines of business and the entire organisation. DUPONT, a US Co. developed and pioneered the systematic use of Return on Assets to evaluate the performance of different organisational units and target areas for improvement. This led to development of Dupont Chart which exhibited the return on assets financial control system.
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Central Measure
Central measure in Dupont Analysis is ROA. Computed by
Numerator will comprise of only Operating Income
ROA =
Operating Profit
Average Operating Assets
Share Holders fund + long term Debt = Capital Employed Only Deployed in acquiring Operating Assets and excluded temporarily investment In other Assets and WIP
Detail Analysis :
ROA is Barometer of the Entries Performance. For more Detailed analysis, the Dupont system breaks the RoA ratio into two components: A Return Ratio : Measure Efficiency (Profitability) A Turnover Ratio : Measures Productivity Thus when two measure profitability & productivity are combined, it produces RoA, a single measure of aggregate performance.
RoA = Net Operating Profit x
Sales
Sales
Return on Sale :
The ratio of operating Profit to Sales is a measure of efficiency that means the ability to control costs at given level of sales activity. Further detail classifications C.O.G.S
N.O.P Ratio [Sales] minus [Operating cost] Admn. Costs Selling Costs Distribution Costs Depreciation
The N.O.P Ratio provides a boarder picture of profitability on sales. Further classification shows each element of coast as % of Sales. This provides management a complete and comprehensive view of the contribution of each cost element to overall profitability on sales.
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This all cost elements contributes in lowering of the net operating profit. This will enable the management to take into consideration on those cost elements which have been critical in bringing down the profitability ratio. And thus it opportunities and potential to control / reduce the costs & enhance the profitability.
[Operating Assets]
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Fix Assets turnover Ratio: A high fixed assets turnover ratio indicates that production capacity is being effectively used. A low ratio indicates idle capacity and scope of expanding production and sales without additional capital investment. Working capital turnover ratio: Further divided in inventory Turnover Ratio, Debtor Turnover Ratio, etc..
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Growth in fixed assets is normally accompanied by some fixed operating cost. Therefore, growth in sales volume mean higher capacity utilization & the Co.s ability to cover its fixed operating costs. Thus as we know DOL suggest that any increase in sales has a positive magnifying effect on EBIT. A rise in working capital without corresponding rise in sales may indicate that
inventories are piling up or higher credit to fetch sales
the indication is something is wrong some where and it need to be identified and corrective measures taken.
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Conclusion
RoA provides an overall summary of performance A low RoA may signal that something is wrong but not what is wrong. The management will have to dig deeper to discover the problems. RoA subcomponents gives an insight into what is happening to profit. It enables to monitor and analyses costs for improving efficiency and raising productivity. It help to management to identify which units are inefficient and which units are require additional capital to expand capital Through which the object of wealth maximization of owners is achieved.
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Thank you