What is the DuPont Model? Description
The DuPont Model is a technique that can be used to analyze the profitability of a company using traditional performance management tools. To enable this, the DuPont model integrates elements of the Income Statement with those of the Balance Sheet.
Origin of the DuPont Model. History
The DuPont model of financial analysis was made by F. Donaldson Brown, an electrical engineer who joined the giant chemical company's Treasury department in 1914. A few years later, DuPont bought 23 percent of the stock of General Motors Corp. and gave Brown the task of cleaning up the car maker's tangled finances. This was perhaps the first large-scale reengineering effort in the USA. Much of the credit for GM's ascension afterward belongs to the planning and control systems of Brown, according to Alfred Sloan, GM's former chairman. Ensuing success launched the DuPont model towards prominence in all major U.S. corporations. It remained the dominant form of financial analysis until the 1970s.
Calculation of DuPont. Formula
Return on Assets = Net Profit Margin x Total Assets Turnover = Net Operating Profit After Taxes / Sales x Sales / Average Net Assets
Usage of the DuPont Framework. Applications
* The model can be used by the purchasing department or by the sales department to examine or demonstrate why a given ROA was earned.
* Compare a firm with its colleagues.
* Analyze changes over time.
* Teach people a basic understanding how they can have an impact on the company results.
* Show the impact of professionalizing the purchasing function.
Steps in the DuPont Method. Process
1. Collect the business numbers (from the finance department).
2. Calculate (use a spreadsheet).
3. Draw conclusions.
4. If the conclusions seem unrealistic, check the numbers and recalculate.
Strengths of the DuPont Model. Benefits
* Simplicity. A very good tool to teach people a basic understanding how they can have an impact on results.
* Can be easily linked to compensation schemes.
* Can be used to convince management that certain steps have to be taken to professionalize the purchasing or sales function. Sometimes it is better to look into your own organization first. In stead of looking for company takeovers in order to compensate lack of profitability by increasing turnover and trying to achieve synergy.
Limitations of the DuPont analysis. Disadvantages
* Based on accounting numbers, which are basically not reliable.
* Does not include the Cost of Capital.
* Garbage in, garbage out.
Assumptions of the DuPont method. Conditions
* Accounting numbers are reliable.
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