DuPont Formula

Dupont Formula, derived by the Dupont Corporation in 1920, calculates Return on Equity (ROE) by dividing it into three parts – Profit Margins, Total Asset Turnover, and the Leverage Factor and is effectively used by investors and financial analysts to identify how a company is generating its return on shareholders equity.

Here’s the formula of Return on Equity as per the DuPont Corporation –

• The DuPont formula created by the DuPont corporation tries to calculate the return on equity using three different instruments: profit margins, total asset turnover, and leverage factors. 
• It means that the investor can understand the company's performance based on its returns on shareholders' equity. The DuPont formula's return on equity is calculated by multiplying the three factors of profit margins, total asset turnover, and leverage factors. 
• On multiplying the three factors, the outcome, thus arrived, is the shareholders' equity or the net income. This formula helps investors understand the firm's profitability, how effectively it allocates resources, and how established it is. 

Here’s a simple example to illustrate DuPont ROE formula.

Sutra Co. has the following information –

• Net Income of the year - $50,000
• Revenues of the year - $300,000
• Total Assets of the company - $900,000
• Shareholders’ Equity - $150,000

Using the DuPont ROE formula, we get –

• Return on Equity = Profit Margin * Total Asset Turnover * Leverage Factor
• Or, Dupont ROE = Net Income / Revenues * Revenues / Total Assets * Total Assets / Shareholders’ Equity
• Or, Dupont ROE = $50,000 / $300,000 * $300,000 / $900,000 * $900,000 / $150,000
• Or, Dupont ROE = 1/6 * 1/3 * 6 = 1/3 = 33.33%.

If we directly find out the Return on Equity, we will get –

• Return on Equity = Net Income / Shareholders’ Equity
• Or, ROE = $50,000 / $150,000 = 1/3 = 33.33%.

In the DuPont formula example below, we calculate the Dupont ROE of Colgate.

• Net income is taken after the minority shareholder’s payment. Therefore, shareholder’s equity consists of only the common shareholders of Colgate (not including the minority holders).
• Asset turnover has been declining over the past 7-8 years. In addition, Colgate's profit margins have also declined over the past 5-6 years.
• However, Return on Equity has not shown a declining trend. It is increasing overall.
• This is because of the Equity Multiplier (total assets / total equity). We note that the Equity Multiplier has shown a steady increase over the past five years and stands at 30x.

If we break down this formula, we will be able to make sense of how it works.

• The first component of the formula is the net profit margin. If we look at the profit margin, it would be – Net Income / Revenues.
• The second component of the formula is total asset turnover. If we look at the formula of total asset turnover, it would be – Revenues / Total Assets.
• The third component in the above formula is Equity Multiplier. If we look into the formula of leverage factor, we will get – Total Assets / Shareholders' Equity.

Now, if we put these three components as DuPont Corporation determined, we will get –

• Return on Equity  = Profit Margin * Total Asset Turnover * Leverage Factor
• Or, Return on Equity = Net Income / Revenues * Revenues / Total Assets * Total Assets / Shareholders’ Equity

The magic of this particular formula is, when we multiply these three, ultimately, we get – Net Income / Shareholders' Equity.

However, if we look at each, we would be able to understand the total four ratios together.

• First, we will get to know what the profitability of the company is.
• Second, we will be able to understand how efficiently the company has been utilizing its assets.
• Third, how much leverage a company has been getting.
• Fourth, we will also understand the return on equity overall.

In the return on equity formula, we not only include common shares, but take taking preferred shares and dividends into account.

Shareholders' equity means we will take the total figure at the end.

Every investor needs to be thorough with the financial ratios before ever investing in any company.

• It helps investors save time and effort. And simultaneously, they would understand how efficiently a company is utilizing its resources and how leveraged the company is.
• ROE throws light on the proportion between net income and the shareholders' equity; it doesn't allow us to understand how much profitability a firm has, how the firm has been utilizing its assets etc.
• With this formula, you can calculate all. All you need to do is look into the income statement, the balance sheet, and the shareholders’ equity statement.

Let us now do the same DuPont formula example above in Excel. This is very simple. You need to provide the two inputs of Net Income, Total Assets, Revenues, and Shareholders' Equity.

You can easily calculate the ratio in the template provided.

If we directly find out the ROE, we will get –