du pont
TRANSCRIPT
DuPont System DuPont System For Financial For Financial
AnalysisAnalysisBy Kevin Bernhardt, UW-Platteville and UW-By Kevin Bernhardt, UW-Platteville and UW-
ExtensionExtensionMarch 10, 2010March 10, 2010
http://cdp.wisc.edu/Management.htm
First,First,This Thing This Thing Called DebtCalled Debt
Anatomy of Returns
Total Assets = Total Liabilities + Total Equity
Total amount of stuff used in the business to make profits (supplies, inputs breeding stock,
machinery, etc.)
How much of that stuff is
financed by the “bank”, that is,
debt capital.
How much of that stuff is financed by
your own money, that is, equity capital.
So, when you make profits, those profits are a return to all the assets, some of which is a return to your money invested (equity capital) and some of which is a return
to the bank’s money (debt capital).
Anatomy of Returns – Case 1
$1,000 of Total Assets (all financed by my own money) generated $500 of total revenue, $400
of total expenses, and thus $100 of profits.
1001000
=
$10 cents of income per dollar
of asset
ROROA = 10%
Since it is all my money, then ROROE = 10%
Anatomy of Returns – Case 2$1,000 of Total Assets (financed $700 by my own money and $300 @8% borrowed from a bank) generated $500 of total revenue, $400 of expenses before interest for $100 profit,
and $76 profits after interest expenses.
$700
76700
=
$300
My money(Equity Capital)
Bank’s money(Debt capital)
1001000
=$10.9 cents of income
per dollar of your money
Before interest $.10 cents of income per dollar of all
assets used.Total Assets $1000
ROROA = 10%
ROROE = 10.9%
ROROA>i-rate The extra is payment to equity 10% 8% Thus 2% additional to Equity
I leveraged someone else’s money to increase the return to my money.
Anatomy of Returns – Case 2$1,000 of Total Assets (financed $700 by my own money and $300 @8% borrowed from a bank) generated $500 of total revenue, $400 of expenses before interest for $100 profit,
and $76 profits after interest expenses.
ROROA>i-rate Thus ROROE>ROROA (that’s good)
Return on equity capital 10% * $700 $70
Return on debt capital (10%-8%) * $300 $6
Total return $76
$76/$700 = 10.9% ROROE
Anatomy of Returns – Case 3$1,000 of Total Assets (financed $700 by my own money and $300 @8% borrowed from a bank) generated $500 of total revenue, $500 of expenses before interest for $0 profit, and
-$24 profits after interest expenses.
$700
-24700
=
$300
My money(Equity Capital)
Bank’s money(Debt capital)
01000
=-$3.4 cents of income
per dollar of your money
Before interest $0 cents of income per dollar of
all assets used.Total Assets $1000
ROROA = 0%
ROROE = -3.4%
Making 0% on all assets, but paying 8%, and the additional 8% is coming out of equity.
Anatomy of Returns – Case 3$1,000 of Total Assets (financed $700 by my own money and $300 @8% borrowed from a bank) generated $500 of total revenue, $500 of expenses before interest for $0 profit, and
-$24 profits after interest expenses.
ROROA<i-rate Thus ROROE<ROROA (Not Good)
Return on equity capital 0% * $700 $0
Return on debt capital (0%-8%) * $300 -$24
Total return -$24
-$24/$700 = -3.4% ROROE
Anatomy of Returns – Case 4$1,000 of Total Assets (financed $700 by my
own money and $300 @15% borrowed from a bank) generated $500 of total revenue, $400 of expenses before interest for $100 profit,
and $55 profits after interest expenses.
$700
55700
=
$300
My money(Equity Capital)
Bank’s money(Debt capital)
1001000
=$7.9 cents of income
per dollar of your money
Before interest $.10 cents of income per dollar of all
assets used.Total Assets $1000
ROROA = 10%
ROROE = 7.9%
Making 10% on all assets, but paying 15% on debt portion (ROROA<i-rate), and the difference must come from equity.
Anatomy of Returns – Case 4$1,000 of Total Assets (financed $700 by my
own money and $300 @15% borrowed from a bank) generated $500 of total revenue, $400 of expenses before interest for $100 profit,
and $55 profits after interest expenses.
ROROA<i-rate Thus ROROE<ROROA (Not Good)
Return on equity capital 10% * $700 $70
Return on debt capital (10%-15%) * 300 -$15
Total return $55
$55/$700 = 7.9% ROROE
So, How Is Money Made?
• Through Three Primary Levers– By being efficient with your operations– By getting the most out of your assets– By leveraging your money
• that is, helping your own money do bigger and better things through borrowed use of someone else’s money.
So, How Can I Analyze How I am Doing At Making Money, Or better yet how I might make
more money?
• By analyzing each of the three levers that leads to Return on Equity – ROROE:– Efficiency of operations– How well assets are working into profits– Leverage
Introducing the DuPont System for Financial Analysis
DuPont System
• Developed in 1919 by a finance executive at E.I. du Pont de Nemours and Co
• “The DuPont system is a way of visualizing the information so that everyone can see it.” (Stephen Jablonsky, Penn State University)
• DuPont analysis “is a good tool for getting people started in understanding how they can have an impact on results” (Doug McCallen, Caterpillar Inc.)
• “Number one, it’s simple” (Sam Siegel, CFO)
DuPont System
• “DuPont Financial Analysis Model is a rather straightforward method for assessing the factors that influence a firm’s financial performance.” (Gunderson, Detre, and Boehlje, AgriMarketing 2005)
DuPont System – What is It?
• The system identifies profitability as being impacted by three different levers:
1. Earnings & efficiency in earnings
2. Ability of your assets to be turned into profits
3. Financial leverage
Earnings
TurningsLeverage
Operating Profit Margin
Asset Turnover
Return On Assets (less interest adj.)
Financial Structure
Return On Equity
X =
X =
IncomeStream
InvestmentStream
Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
Operating Profit Margin
Asset Turnover
Return On Assets (less interest adj.)
Financial Structure
Return On Equity
X =
X =
IncomeStream
InvestmentStream
Earnings
Turnings
Leverage
DuPont System Ratios
OPMR
ROROA
ROROE
ATO
Total Assets/Total Equity
Derived from the Debt To
Asset Ratio (D:A)
Let’s Do The Math
Operating Profit Margin
Asset Turnover
Return On Assets (less interest adj.)
Financial Structure
Return On Equity
X =
X =Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
NFIFO + interest paid - unpaid labor/mgt ROROA = Total Assets
NFIFO + interest pd – unpaid labor/mgt Total Revenue
Total Revenue Total Assets
Rate Of Return On Assets
Operating Profit Margin Ratio
Asset Turnover Ratio
X
Operating Profit Margin
Asset Turnover
Return On Assets (less interest adj.)
Financial Structure
Return On Equity
X =
X =Turnings/Asset Use
Leverage
DuPont System
Earnings/Efficiency
NFIFO – unpaid labor/mgtROROE = Total Equity
NFIFO + interest pd. – unpaid labor/mgt Total Assets
Total Assets Total Equity
Rate Of Return On Equity
Rate Of Return On Assets
Leverage Ratio
- interest pd.Total Assets
i-rate Adj.
= NFIFO – unpaid labor/mgt Total Assets X
Net Farm Income From Operations (NFIFO)
NFIFO = Total Revenue – Basic Costs – Non Basic Costs
sales, govt. pmts, custom work +(-) inventory changes
cash expenses +(-) accrual expense changes
labor + depreciation
+ interest expenses
NFIFO = Total Revenue – COGS – Operating Expenses – Interest
Return On Assets
Total AssetsTotal Equity
Return On Equity
X =
Leverage
Leverage is the mix of debt versus equity capital used in making profits.
- Do we have too much debt?- Do we have enough debt?- Is our debt capital generating profits?- Can our debt capital be put to better use?
OK
Too Low
Too Low
NFIFO – unpaid labor/mgt + interestTotal Revenue
Total RevenueTotal Assets
Return On Assets
Total AssetsTotal Equity
Return On Equity
X =
X =
Earnings
Turnings
Leverage
cash income +(-) inventory changes
cash expenses +(-) accrual exp changes + purch lstk Depr
labor + depreciation + interest expenses
OK
Too Low
OPMR
ATO OK
Too Low
Total Revenue =
Basic Costs =
Non Basic Costs =
OK
Too Low
-Too much labor given output- Not enough labor-Training and Education- Better systems and processes- Weekly/Daily staff meetings- Performance metrics
NFIFO – unpaid labor/mgt + interestTotal Revenue
Total RevenueTotal Assets
Return On Assets
Total AssetsTotal Equity
Return On Equity
X =
X =
Earnings
Turnings
Leverage
OPMR
ATO
Too Low
OK
Too Low
OK
Too Low
-Unproductive machinery? - Buildings not being used? - Breeding livestock not producing? - Unproductive land?- Over valued assets?
Also, selling off unproductive assets and paying off debt could change your leverage position in a positive way, and also improve your ROROE!
Financial Diagnostics via DuPont. Finding the Red
Flags!
ROROE too Low
ROROA too Low
Revenues too low for costs
Unused or Under
Utilized Assets
Obsolete or Inefficient
Assets
Leverage
Wrong Kind of Debt
Not Enough Debt
OPM too Low
ATO too Low
Costs too high for Revenues
PricesProduction
QualityFacilities
ProcessesOperations
HealthLabor
RepairsTimeliness
Management
Ability to Manage Assets
Endhttp://cdp.wisc.edu/Management.htm
NFIFO+int
- unpd mgt 11.7 2007 31,157 3.4 2008 1,665 6.12 5 yr avg
OPM
÷ 4.1% 751,348 0.2% 757,926
Earnings GR
NFIFO – unpaid labor/mgtROROE = Total Equity
NFIFO – unpaid labor/mgt + interest pd.ROROA = Total Assets
NFIFO – unpaid labor/mgt + interest pd.OPMR = Total Revenue
Total RevenueATO = Total Assets
Total AssetsFinancial Structure = Total Equity
Rate Of Return On Equity
Rate Of Return On Assets
Operating Profit Margin Ratio
Asset Turnover Ratio
Leverage Ratio