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Financial Statement Analysis - DuPont & Pyramid Ratios

Dr. Clive Vlieland-Boddy

Pyramid Formulas
These take a basic formula and expand it. They enable a basic formula to be decomposed. The most common one is DuPont

So, How Is Money Made?


Through Three Primary Levers By being efficient with your operations By getting the most out of your assets By leveraging your money
that is, helping your own money do bigger and better things through borrowed use of someone elses money.

How Can I Analyze How I am Doing At Making Money? How I might make more money?
By analyzing each of the three levers that leads to Return on Equity ROE:
Profitability of the operations How efficient assets are being made to work Leverage ( the right mix of Equity to Debt)

How Can Return On Equity Be Expanded?


The basic Formula says the return that the shareholders are getting.

The Return on Equity (ROE)


Based on Net Earnings before dividends compared to the average shareholder funds.

Introducing the DuPont System for Financial Analysis

DuPont System
Developed in 1919 by a finance executive at E.I. du Pont de Nemours and Co A way of visualizing the information so that everyone can see it Is a good tool for getting people started in understanding how they can have an impact on results It is simple and straightforward
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The DuPont System


Method to breakdown ROE into:
ROA and Equity Multiplier

ROA is further broken down as:


Profit Margin (profitability) Asset Turnover (efficiency in using the assets)

Helps to identify sources of strength and weakness in current performance Helps to focus attention on value drivers
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DuPont System What is It?


The system identifies profitability as being impacted by three different levers:
Earnings & efficiency in earnings Earnings Ability of your assets to be turned into profits Financial leverage Leverage

Efficiency

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Return on Equity - ROE


This represents the Net income generated by the Equity invested in the business The Formula is:
Net Income Equity This represents $s of profit per $ invested by the shareholders.
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Basic Equation!
A

Equals

Expand.

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Back to basic Mathematics


A simple equation:

A
x

Y
Z

Z
x

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Back to basic Maths


A simple equation:

A
x

Y
Z

Z
x

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Back to basic Maths


A

Equals

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ROE
Net Income
= Total Equity

Net Profit Margin


Net Income
X

Total Asset Turnover


Sales
X

Debt Ratio
Total Assets
Total Equity Leverage

Sales Profitability

Total Assets
Asset Usage Efficiency

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So what does the DuPont say?


DuPont analysis tells us that ROE is affected by three things: - Operating efficiency, which is measured by profit margin. - Asset use efficiency, which is measured by total asset turnover. - Financial leverage is measured by the equity multiplier

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The DuPont System


ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

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The DuPont System


ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

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The DuPont System


ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

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The DuPont System


ROE ROA Profit Margin Equity Multiplier

Total Asset Turnover

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DuPont Equation

ROE Profit Margin Total Asset Turnover Equity Multiplier Net Income Sales Total Assets Sales Total Assets Common Equity

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DuPont System
Earnings/Profitability

Operating Profit Margin


Income Stream X = Return On Assets (less interest adj.) X = Return On Equity

Asset Turnover
Asset Efficiency Usage

Investment Stream

Financial Structure Leverage


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DuPont System Ratios


Profitability

Operating Profit Margin


Income Stream X = Return On Assets (less
interest adj.)

Asset Turnover
Efficiency

Return On Equity

Investment Stream

Financial Structure Leverage


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Lets do the Numbers!


Using Whitbread Plc 2009 and 2008 accounts

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Whitbread Plc Key Figures


Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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DuPont System
Profitability

Operating Profit Margin


X = Return On Assets ROA

We can firstly Expand ROA

Asset Turnover
Efficiency/Asset Use

Return On Equity

Financial Structure Leverage


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Whitbread Plc Key Figures


Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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Return On Assets Net Income (Profits) ROA = Total Assets

90.3m 2,495m

Can be expanded to:


Net Profit Margin - Profitability Net Income (Profit) Total Revenue/Sales Asset Turnover Ratio - Efficiency Total Revenue/Sales Total Assets

90.3m
1,334.6m

1,334.6m
2,495m
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If you delete the Total Revenues you return to ROA

Whitbread Plc Key Figures


Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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DuPont System
Profitability

Operating Profit Margin


X = Return On Assets (less interest adj.) X =

Now we can look at the effect of leverage


Return On Equity

Asset Turnover Efficiency/Asset Use

Financial Structure Leverage


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Whitbread Plc Key Figures


Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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Return On Equity
Net Income (Profits) ROROE = Total Equity

90.3m
= 1,222.5m

Return On Assets Net Income (Profits) ROA = Total Assets

Leverage Ratio Total Assets Total Equity

90.3m = 2,495m X

2,495m 1,222.5m
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If you delete the Total Assets you return to ROE

Whitbread Plc Key Figures


Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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Leverage is the mix of debt versus equity capital used in making profits.

Return On Assets

OK

- 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?

Return On Equity

Too Low

Leverage

Total Assets Total Equity

Too Low
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Example of DuPont

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Compare Whitbread a UK brewery against its industry

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Combination of all three factors


Whitbread The Industry

Profitability Efficiency Leverage

6.77% .535 2.04%

8.10% .74 2.00%

Whitbread: 6.77% x .535 x 2.04% = 7.39% Industry: 8.10% x .74 x 2.00% = 11.99
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Disaggregating Return on Assets

Bye for now!

Im ready for some leisure time.

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