DuPont System

For Financial
Analysis
By Kevin Bernhardt, UW-Platteville and UWExtension
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.
I leveraged someone elses money
to increase the return to my money.

ROROE = 10.9%

76
700

My money
(Equity Capital)

$700
Total Assets

$300
Banks money
(Debt capital)

$1000

100
1000

$10.9 cents of income

per dollar of your
money
Before interest $.10 cents
of income per dollar of all
assets used.
ROROA = 10%

ROROA>i-rate The extra is payment to equity

10%
8% Thus 2% additional to Equity

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

Anatomy of Returns Case 3

$1,000 of Total Assets (financed $700 by my
own money and $300 @8% borrowed from a
bank) generated $500 of total revenue, $500
of expenses before interest for $0 profit, and
-$24 profits after interest expenses.
ROROE = -3.4%

-24
700

My money
(Equity Capital)

-$3.4 cents of income

per dollar of your
money

Before interest $0 cents

of income per dollar of
all assets used.

$700
Total Assets

$300
Banks money
(Debt capital)

$1000

0
1000

ROROA = 0%
Making 0% on all assets, but paying 8%, and
the additional 8% is coming out of equity.

Anatomy of Returns Case 3

$1,000 of Total Assets (financed $700 by my
own money and $300 @8% borrowed from a
bank) generated $500 of total revenue, $500
of expenses before interest for $0 profit, and
-$24 profits after interest expenses.
ROROA<i-rate Thus ROROE<ROROA (Not Good)
Return on equity capital
0% * $700
$0
Return on debt capital
(0%-8%) * $300
-$24
Total return

-$24
-$24/$700 = -3.4% ROROE

Anatomy of Returns Case 4

$1,000 of Total Assets (financed $700 by my
own money and $300 @15% borrowed from a
bank) generated $500 of total revenue, $400
of expenses before interest for $100 profit,
and $55 profits after interest expenses.
ROROE = 7.9%

55
700

My money
(Equity Capital)

$700
Total Assets

$300
Banks money
(Debt capital)

$1000

100
1000

$7.9 cents of income

per dollar of your
money
Before interest $.10 cents
of income per dollar of all
assets used.
ROROA = 10%

Making 10% on all assets, but paying 15% on debt portion

(ROROA<i-rate), and the difference must come from equity.

Anatomy of Returns Case 4

$1,000 of Total Assets (financed $700 by my
own money and $300 @15% borrowed from a
bank) generated $500 of total revenue, $400
of expenses before interest for $100 profit,
and $55 profits after interest expenses.
ROROA<i-rate Thus ROROE<ROROA (Not Good)
Return on equity capital
10% * $700
$70
Return on debt capital
(10%-15%) * 300 -$15
Total return

$55
$55/$700 = 7.9% ROROE

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.

So, How Can I Analyze How I am

Doing At Making Money, Or
better yet how I might make
more money?
By analyzing each of the three levers that
leads to Return on Equity ROROE:
Efficiency of operations
How well assets are working into profits
Leverage

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
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 Earnings
2. Ability of your assets to be turned into profits
Turnings
3. Financial leverage Leverage

DuPont System
Earnings/Efficiency

Operating
Profit Margin
Income
Stream

Asset
Turnover
Turnings/Asset Use

Investment
Stream

Financial
Structure
Leverage

Return On
Assets (less
interest adj.)
X

Return On
Equity

DuPont System Ratios

Earnings

Operating
Profit Margin
Income
Stream

interest adj.)

Asset
Turnover
Turnings

Investment
Stream

Return On
Assets (less

Financial
Structure
Leverage

Return On
Equity

Lets Do The Math

DuPont System
Earnings/Efficiency

Operating
Profit Margin
X

Asset
Turnover
Turnings/Asset Use

Financial
Structure
Leverage

Return On
Assets (less
interest adj.)
X

Return On
Equity

Rate Of Return On Assets

NFIFO + interest paid - unpaid labor/mgt
ROROA =
Total Assets

Operating Profit Margin Ratio

NFIFO + interest pd unpaid labor/mgt
Total Revenue

Asset Turnover Ratio

Total Revenue
Total Assets

DuPont System
Earnings/Efficiency

Operating
Profit Margin
X

Asset
Turnover
Turnings/Asset Use

Financial
Structure
Leverage

Return On
Assets (less
interest adj.)
X

Return On
Equity

Rate Of Return On Equity

NFIFO unpaid labor/mgt

ROROE =
Total Equity

i-rate Adj.

Rate Of Return On Assets

NFIFO + interest pd. unpaid labor/mgt
Total Assets

interest pd.
Total Assets

Leverage Ratio

NFIFO unpaid labor/mgt

Total Assets

Total Assets
Total Equity

Net Farm Income From Operations

(NFIFO)
NFIFO = Total Revenue Basic Costs Non Basic Costs
sales, govt. pmts,
custom work +(-)
inventory changes

labor
+ depreciation
+ interest expenses

cash expenses
+(-) accrual expense changes

NFIFO = Total Revenue COGS Operating Expenses Interest

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?

Leverage

Total Assets
Total Equity

Too Low

Return On
Assets

OK

Return On
Equity

Too Low

Total Revenue =

OK

cash income +(-) inventory changes

Basic Costs = cash expenses +(-) accrual exp changes + purch lstk Depr
Non Basic Costs = labor + depreciation + interest expenses

Earnings

NFIFO unpaid labor/mgt + interest

Total Revenue

X
Turnings

Total Revenue
Total Assets

ATO

-Too much labor given output

- Not enough labor
-Training and Education
- Better systems and processes
- Weekly/Daily staff meetings
- Performance metrics
Leverage

Total Assets
Total Equity

OK

Too Low

OPMR

Return On
Assets

Too Low

OK

Return On
Equity

Too Low

Earnings

NFIFO unpaid labor/mgt + interest

Total Revenue

X
Turnings

Total Revenue
Total Assets

ATO

-Unproductive machinery?
- Buildings not being used?
- Breeding livestock not producing?
- Unproductive land?
- Over valued assets?

Leverage

Total Assets
Total Equity

OK

OK

OPMR

Return On
Assets

Too Low

Too Low

Return On
Equity

Too Low
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!
Prices
Production
Quality
Facilities
Processes
Operations
Health
Labor
Repairs
Timeliness
Management
Ability to
Manage
Assets

Revenues too
low for costs
OPM too
Low
Costs too high
for Revenues

ROROA
too Low
ATO too
Low

Obsolete or
Inefficient
Assets
Unused or
Under
Utilized
Assets

ROROE
too Low

Wrong Kind of
Debt
Leverage
Not Enough
Debt

End
http://cdp.wisc.edu/Management.htm

NFIFO
+int
- unpd mgt
31,157
1,665

751,348
757,926

11.7
3.4
6.12
OPM
4.1%
0.2%
Earnings

GR

2007
2008
5 yr avg

Rate Of Return On Equity

NFIFO unpaid labor/mgt
ROROE =
Total Equity
Rate Of Return On Assets
NFIFO unpaid labor/mgt + interest pd.
ROROA =
Total Assets
Operating Profit Margin Ratio
NFIFO unpaid labor/mgt + interest pd.

OPMR =
Total Revenue
Asset Turnover Ratio
Total Revenue
ATO =
Total Assets
Leverage Ratio
Total Assets
Financial Structure =
Total Equity