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A financial analysis methodology called DuPont analysis commonly referred to as the DuPont model is used to assess a company's profitability by analyzing its return on equity (ROE). The DuPont Corporation created the framework in the 1920s to better analyze its own financial performance, and it bears its name.
The three components of net profit margin, asset turnover, and financial leverage make up the DuPont analysis' breakdown of a company's ROE. Asset turnover gauges how well a corporation uses its assets to create revenue, while net profit margin shows the amount of revenue that a business retains as profit after deducting all costs. Financial leverage is a measure of how much debt is used to fund a business' operations and investments.
The formula for the DuPont analysis is as follows:
ROE = Net Profit Margin x Asset Turnover x Financial Leverage.
The DuPont analysis clarifies how a firm obtains its ROE and identifies the company's strengths and shortcomings by examining each of these elements. A high net profit margin, for instance, might show that a business is managing its costs well, while a high asset turnover might show that it is effectively leveraging its assets to produce sales. High amounts of debt can make a company more vulnerable to financial shocks and economic downturns, which could make high financial leverage also enhance a company's risk profile.
