A Complete Ratio Analysis

No single ratio is adequate for assessing all aspects of the firm's financial condition. Two popular approaches to a complete ratio analysis are: the DuPont system of analysis and the summary analysis of large number of ratios (see: Table 5-7).

Dupont System Of Analysis

The assessment is particularly valuable as the company's products reach the maturity phase of the product life cycle. DuPont formula, a method of using financial ratios to determine return on assets (ROA). The DuPont system first brings together the net profit margin, which measures the firm's profitability on sales, with it total assets turnover, which indicates how efficiently the firm has used its assets to generate sales. The product of these two ratio results in the return on assets (ROA):

ROA = net profit margin x total assets turnover

Substituting the appropriate formulas into the equation and simplifying results in the formula given earlier,

ROA = net profits after taxes x Sales
Sales Total assets

Figure 5-3 which is called a DuPont chart (because the company's mangers developed the general approach) depicts the basic DuPont system with Metro Manufacturing monetary and ratio value.

The net profit margin and total asset turnover for Metro substituted into the DuPont formula, the result is

ROA = 5.1% x 1.51 = 7.72%

The second step in the DuPont system employs the modified DuPont formula:

ROE = ROA x Equity multiplier

Substituting the appropriate formulas into the equation and simplifying results in the formula given earlier,

ROE = net income x assets
assets equity
ROE = Net income

Substituting the values for Metro's ROA of 7.72%, calculate earlier, and Metro's equity multiplier of 1.58 into the modified DuPont formula yields:

ROE = 7.72% x 1.58 = 12.2%

The 12.2 percent ROE calculated using the modified DuPont formula is the same as that calculated directly. The advantage of the DuPont system is that allows the company to break its return on equity into a profit-onsales component (net profit margin), an efficiency-ofasset- use component (total asset turnover), and a useof-leverage component (equity multiplier).

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Finance For Strategic Management
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