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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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A

Equals

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ROE
Net Income
= Total Equity

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

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## The DuPont System

ROE ROA Profit Margin Equity Multiplier

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## The DuPont System

ROE ROA Profit Margin Equity Multiplier

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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

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Profitability

## Operating Profit Margin

Income Stream X = Return On Assets (less

Asset Turnover
Efficiency

Return On Equity

Investment Stream

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## Lets do the Numbers!

Using Whitbread Plc 2009 and 2008 accounts

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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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Sales Net Earnings
Average Total Assets Average Total Equity

1,334.6 90.3
2,495.0 1,222.5

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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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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 =

Return On Equity

## Financial Structure Leverage

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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

## Leverage Ratio Total Assets Total Equity

90.3m = 2,495m X

2,495m 1,222.5m
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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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## 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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