The DuPont identity, a widely used technique in finance, is an expression which breaks a company´s return on equity (ROE) down into three parts and shows how it is the product of three other ratios:

• The profit margin. The profit margin measures operating efficiency.
• The total asset turnover. The total asset turnover measures asset use efficiency.
• The equity multiplier. The financial leverage is measured by the equity multiplier.

This concept DyPont identity is also known as the DuPont analysis, the DuPont equation, the DuPont frameworkd, the DuPont model, and the DuPont method. It is named after the DuPont company. In 1912, the DuPont explosives salesman Frank Donaldson Brown came up with the formula for an internal efficiency report, and in the 1920, the company began using it more extensively.

## Why use DuPont identity?

When ROE is unsatisfactory, the DuPont identity can help the company management (and third-party analysts) better understand which part of the business that is underperforming and needs to be adjusted.

## The formula for the DuPont identity

ROE = profit margin x asset turnover x equity multiplier

### Breakdown

ROE = (net income / sales) x (revenue / total assets) x (total assets / shareholder equity)

## Example calculation

This is the financial data reported by Company XYZ for the previous two years:

### Year 1

• Net income = \$180,000
• Revenues = \$300,000
• Total assets = \$500,000
• Shareholder equity = \$900,000

### Year 2

• Net income = \$170,000
• Revenues = \$327,000<
• Total assets = \$545,000
• Shareholder equity = \$980,000

### Calculations

The ROE for Year 1:

(\$180,000 / \$300,000) x (\$300,000 / \$500,000) x (\$500,000 / \$900,000) =

0.6 x 0.6 x 0,56 = 0, 2016

The ROE for Year 1 is 20%

The ROE for Year 2:

(\$170,000 / \$327,000) x (\$327,000 / \$545,000) x (\$545,000 / \$980,000) =

= 0.52 x 0.6 x 0.56 = 0.1747

The ROE for Year 1 is 17%.

### Conclusions

Anyone analysing this company can see that ROE is lower for the second year compared to the first year. By looking closer at the DuPont identity, we can break down where the decline is happening, and which areas that need attention. During year 2, revenues went up, so what is wrong?

Looking at the DuPoint identity, we can see that the total asset turnover and the equity multiple remained constant. Therefore, the change has happened in the profit margin. We look at the profit margin, and see that it dropped from 60% to 52%, despite the increased revenues. This indicates that we should look for issues pertaining to how the company has handled its costs in year two.