An analysis of company performance using DuPontanalysis
Walking down the hall of your office building with a sheaf ofpapers in his hand, your friend and colleague, Akira, stepped intoyour office and asked the following.
AKIRA: Do you have 10 or 15 minutes that you can spare?
YOU: Sure, I’ve got a meeting in an hour, but I don’t want tostart something new and then be interrupted by the meeting, so howcan I help?
AKIRA: I’ve been reviewing the company’s financial statementsand looking for general ways to improve our performance, ingeneral, and the company’s return on equity, or ROE, in particular.Emma, my new team leader, suggested that I start by using a DuPontanalysis, and I’d like to run my numbers and conclusions by you, tosee if I’ve missed anything.
Here are the balance sheet and income statement data that Emmagave me, and here are my notes with my calculations. Could youstart by making sure that my numbers are correct?
YOU: Give me a minute to look at these financial statements andto remember what I know about the DuPont analysis.
Balance Sheet Data | Income Statement Data |
|---|
| Cash | $1,300,000 | Accounts payable | $1,560,000 | Sales | $26,000,000 |
| Accounts receivable | 2,600,000 | Accruals | 520,000 | Cost of goods sold | 15,600,000 |
| Inventory | 3,900,000 | Notes payable | 2,080,000 | Gross profit | $10,400,000 |
| Current assets | $7,800,000 | Current liabilities | $4,160,000 | Operating expenses | 6,500,000 |
| | Long-term debt | 4,420,000 | EBIT | $3,900,000 |
| | Total liabilities | $8,580,000 | Interest expense | 780,000 |
| | Common stock | 1,755,000 | EBT | $3,120,000 |
| Net fixed assets | 7,800,000 | Retained earnings | 5,265,000 | Taxes | 1,092,000 |
| | Total equity | $7,020,000 | Net income | $2,028,000 |
| Total assets | $15,600,000 | Total debt and equity | $15,600,000 | | |
If I remember correctly, the DuPont equation breaks down our ROEinto three component ratios: the ???????????? , the total assetturnover ratio, and the ????????????????? .
And, according to my understanding of the DuPont equation andits calculation of ROE, the three ratios provide insights into thecompany’s ?????????????? , effectiveness in using the company’sassets, and ???????????????? .
Now, let’s see your notes with your ratios, and then we can talkabout possible strategies that will improve the ratios. In thedropdown lists next to your values I’m going to select correct ifyour calculation is correct and incorrect if your calculation isincorrect.
| | Canis Major Veterinary Supplies Inc. DuPont Analysis | | |
|---|
| Ratios | Value | Correct/Incorrect | Ratios | Value | Correct/Incorrect |
| Profitability ratios | | | Asset management ratio | | |
| Gross profit margin (%) | 40.00 | ??????????? | Total asset turnover | 1.67 | ?????????? |
| Operating profit margin (%) | 12.00 | ??????????? | | | |
| Net profit margin (%) | 13.00 | ??????????? | Financial ratios | | |
| Return on equity (%) | 39.43 | ??????????? | Equity multiplier | 1.82 | ?????????? |
AKIRA: OK, it looks like I’ve got a couple of incorrect values,so show me your calculations, and then we can talk strategies forimprovement.
YOU: I’ve just made rough calculations, so let me complete thistable by inputting the components of each ratio and its value:
Note: Do not round intermediate calculations. Round finalanswers to the nearest whole number.
Canis Major Veterinary Supplies Inc. DuPont Analysis |
|---|
| | Calculation | | | Value |
| Profitability ratios | Numerator | | Denominator | | |
| Gross profit margin (%) | ?????? | / | ???????? | = | ??? |
| Operating profit margin (%) | ?????? | / | ???????? | = | ??? |
| Net profit margin (%) | ?????? | / | ???????? | = | ??? |
| Return on equity (%) | ?????? | / | ???????? | = | ??? |
| Asset management ratio | | | | | |
| Total asset turnover | ?????? | / | ???????? | = | ??? |
| Financing ratios | | | | | |
| Equity multiplier | ?????? | / | ???????? | = | ??? |
AKIRA: I see what I did wrong in my computations. Thanks forreviewing these calculations with me. You saved me from a lot ofembarrassment! Emma would have been very disappointed in me if Ihad showed her my original work.
So, now let’s switch topics and identify general strategies thatcould be used to positively affect Canis Major’s ROE.
YOU: OK, so given your knowledge of the component ratios used inthe DuPont equation, which of the following strategies shouldimprove the company’s ROE?
Check all that apply.
A) Increase the interest rate on its notes payable or long-termdebt obligations because it will reduce the company’s net profitmargin.
B) Increase the efficiency of its assets so that it generatesmore sales with each dollar of asset investment and increases thecompany’s total asset turnover.
C) Increase the firm’s bottom-line profitability for the samevolume of sales, which will increase the company’s net profitmargin.
D) Use more debt financing in its capital structure and increasethe equity multiplier.
AKIRA: I think I understand now. Thanks for taking the time togo over this with me, and let me know when I can return thefavor.
