Case-2 Airline Profitability Analysis

(The Du Pont method of financial analysis)

(Q-1) What is the DuPont method? That is, how does it differ from
the more familiar ratio analysis?
DuPont Analysis
The DuPont analysis also called the DuPont model is a financial ratio based on the return on equity
ratio that is used to analyse a company’s ability to increase its return on equity. In other words, this
model breaks down the return on equity ratio to explain how companies can increase their return for
investors.
The DuPont analysis looks at three main components of the ROE ratio.
1) Profit Margin
2) Total Asset Turnover
3) Financial Leverage
Based on these three performances measures the model concludes that a company can raise its ROE by
maintaining a high profit margin, increasing asset turnover, or leveraging assets more effectively. The
DuPont Corporation developed this analysis in the 1920s. The name has stuck with it ever since.
Formula
The DuPont Model equates ROE to profit margin, asset turnover, and financial leverage. The basic
formula looks like this.

Since each one of these factors is a calculation in and of itself, a more explanatory formula for this
analysis looks like this.

Every one of these accounts can easily be found on the financial statements. Net income and sales appear
on the income statement, while total assets and total equity appear on the balance sheet.
Analysis
This model was developed to analyse ROE and the effects different business performance measures have
on this ratio. So investors are not looking for large or small output numbers from this model. Instead,
they are looking to analyse what is causing the current ROE. For instance, if investors are unsatisfied
with a low ROE, the management can use this formula to pinpoint the problem area whether it is a lower
profit margin, asset turnover, or poor financial leveraging.
Once the problem area is found, management can attempt to correct it or address it with shareholders.
Some normal operations lower ROE naturally and are not a reason for investors to be alarmed. For
instance, accelerated depreciation artificially lowers ROE in the beginning periods.
DuPont analysis is a potentially helpful tool for analysis that investors can use to make more informed
choices regarding their equity holdings. The primary advantage of DuPont analysis is the fuller picture
of a company's overall financial health and performance that it provides, compared to more limited
equity valuation tools. A main disadvantage of the DuPont model is that it relies heavily on accounting
data from a company's financial statements, some of which can be manipulated by companies, so they
may not be accurate.
DuPont analysis is an equity evaluation approach that uses financial and leverage ratios that expand the
profitability ratio of return on equity (ROE) into a more detailed and comprehensive measure.
The DuPont analysis model provides a more accurate assessment of the significance of changes in a
company's ROE by focusing on the various means that a company has to increase the ROE figures. The
means include the profit margin, asset utilization and financial leverage (also known as financial
gearing). A company can improve any or all of these elements to increase value and returns to
shareholders through its management of costs, choices of financing and usage of assets. DuPont analysis
helps investors pinpoint the source of increased or decreased equity returns.

(Q-2) Using the DuPont method, calculate the profit margin, asset
turnover, return on Assets and return on equity for each of the six
Airlines.
(5) (6) (7) (8)
(1) (3) (4)
PROFIT ASSETS EQUITY ROA ROE
NET (2) TOTAL COMMON MARGIN TURNOVER MULTIPLIER Formula= Formula=
INCOME SALES ASSETS EQUITY formula =1/2 Formula=2/3 Formula=3/4 5*6 5*6*7
476.80 8,824.30 9,792.20 3,148.00 0.05 0.90 3.11 0.05 0.15
A
37.50 814.40 730.20 306.50 (5)
0.05 (6)
1.12 (7)
2.38 0.05
(8) 0.12
B PROFIT ASSETS EQUITY
(1)
306.90 6,915.40
(3)
5,748.30
(4)
2,208.80 0.04 1.20 2.60
ROA
0.05
ROE
0.14
C NET (2) TOTAL COMMON MARGIN TURNOVER MULTIPLIER Formula= Formula=
INCOME SALES ASSETS EQUITY formula =1/2 Formula=2/3 Formula=3/4 5*6 5*6*7
58.00
476.80 860.40
8,824.30 1,308.40
9,792.20 567.40
3,148.00 0.07
0.05 0.66
0.90 2.31
3.11 0.04
0.05 0.10
0.15
DA
1,124.30
37.50 8,981.70
814.40 6,700.70
730.20 1,226.10
306.50 0.13
0.05 1.34
1.12 5.47
2.38 0.17
0.05 0.92
0.12
EB
165.00
306.90 5,707.00
6,915.40 5,348.90
5,748.30 2,069.50
2,208.80 0.03
0.04 1.07
1.20 2.58
2.60 0.03
0.05 0.08
0.14
FC
58.00 860.40 1,308.40 567.40 0.07 0.66 2.31 0.04 0.10
D
1,124.30 8,981.70 6,700.70 1,226.10 0.13 1.34 5.47 0.17 0.92
E
(Q-3) Evaluate the results in terms of the determination of ROE.
165.00 5,707.00 5,348.90 2,069.50 0.03 1.07 2.58 0.03 0.08
F Profit margin
Net
(Q-2)
Net Usingmeasures
Profit margin the DuPont method,
how successful calculate
a company has been atthe
the profit
business margin,
of marking aasset
profit on
each dollar sales.
turnover, It is oneon
return of the most essential
Assets financial on
and return ratios. Net margin
equity forincludes
each of all the
thefactors
six that
influence profitability whether under management control or not. The higher the ratio, the more
Airlines.
effective a company is at cost control. Compared with industry average, it tells investors how well
the management and operations of a company are performing against its competitors. In the calculation
of question No.2, company E has highest profit margin and company F has lowest profit margin. So it
means company E minimizing its cost and maximizing its sales. Net profit margin can be Compare with
different industries; it tells investors which industries are relatively more profitable than others.
Net profit margin analysis is also used among many common methods for business valuation.
Asset Turnover Ratio
The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales from
its assets by comparing net sales with average total assets. In other words, this ratio shows how
efficiently a company can use its assets to generate sales. The total asset turnover ratio calculates net
sales as a percentage of assets to show how many sales are generated from each dollar of company assets.
For instance, a ratio of .5 means that each dollar of assets generates 50 cents of sales. This ratio measures
how efficiently a firm uses its assets to generate sales, so a higher ratio is always more favourable. Higher
turnover ratios mean the company is using its assets more efficiently. Lower ratios mean that the
company isn’t using its assets efficiently and most likely have management or production problems.
For instance, a ratio of 1 means that the net sales of a company equal the average total assets for the
year. In other words, the company is generating 1 dollar of sales for every dollar invested in assets. In
the above case, company E has highest asset turnover ratio. It means company E is using its assets more
efficiently. But company D has lowest asset turnover ratio, it means he is not using its assets efficiently.

Equity Multiplier
The equity multiplier is a financial leverage ratio that measures the amount of a firm’s assets that are
financed by its shareholders by comparing total assets with total shareholder’s equity. In other words,
the equity multiplier shows the percentage of assets that are financed or owed by the shareholders.
Conversely, this ratio also shows the level of debt financing is used to acquire assets and maintain
operations. Like all liquidity ratios and financial leverage ratios, the equity multiplier is an indication of
company risk to creditors. Companies that rely too heavily on debt financing will have high debt service
costs and will have to raise more cash flows in order to pay for their operations and obligations. Both
creditors and investors use this ratio to measure how leveraged a company is. The equity multiplier is a
ratio used to analyse a company’s debt and equity financing strategy. A higher ratio means that more
assets were funding by debt than by equity. In other words, investors funded fewer assets than by
creditors. When a firm’s assets are primarily funded by debt, the firm is considered to be highly leveraged
and riskier for investors and creditors. This also means that current investors actually own less of the
company assets than current creditors. Lower multiplier ratios are always considered more conservative
and more favourable than higher ratios because companies with lower ratios are less dependent on debt
financing and don’t have high debt servicing costs. In the above case, company D has lowest leverage.
It means company D is better than all of other airline companies. On the other hand, company E has
highest leveraged. So we can easily say that company E is riskier for investors.

Return on Assets Ratio – ROA

The return on assets ratio, often called the return on total assets, is a profitability ratio that measures the
net income produced by total assets during a period by comparing net income to the average total assets.
In other words, the return on assets ratio or ROA measures how efficiently a company can manage its
assets to produce profits during a period. Since company assets’ sole purpose is to generate revenues
and produce profits, this ratio helps both management and investors see how well the company can
convert its investments in assets into profits. You can look at ROA as a return on investment for the
company since capital assets are often the biggest investment for most companies. In this case, the
company invests money into capital assets and the return is measured in profits. In short, this ratio
measures how profitable a company’s assets are.
The return on assets ratio measures how effectively a company can earn a return on its investment in
assets. In other words, ROA shows how efficiently a company can convert the money used to purchase
assets into net income or profits. Since all assets are either funded by equity or debt, some investors try
to disregard the costs of acquiring the assets in the return calculation by adding back interest expense in
the formula. It only makes sense that a higher ratio is more favourable to investors because it shows that
the company is more effectively managing its assets to produce greater amounts of net income. A
positive ROA ratio usually indicates an upward profit trend as well. In the above comparisons of airlines
companies, ROA of company E showing than company E using his assets better than all of other airlines.
While ROA of company F showing that it using his assets very inefficiency. ROA is most useful for
comparing companies in the same industry as different industries use assets differently. For instance,
construction companies use large, expensive equipment while software companies use computers and
servers.

(Q-4) Robert Williams wondered if an Airline’s revenue could be

increased simply by increasing its yield (price per passenger
miles). Using figure 2 as a frame of reference, what do you think?
I think, increase in yield (price per passenger mile) is not a good decision, because in airline business,
major part of the profit is participated by economy class. And one characteristics of this class is that it
shifts immediately toward those airlines who offer lower prices. If they try to increase the price, then
automatically (due to decrease in economy class) sale will be decree. And when the sale will be decrease,
then load factor will also be decrease. And when load factor will be decrease, then profit will
automatically be decrease. So it is not a good decision.

(Q-5) Does the DuPont method seem relevant for the airline industry?
Why or why not?
Determinants of ROE, which are exists in any other industry are also exist in airline industry. Like
efficiency, asset usage & leverage. Efficiency is important, asset usage (means load factor) is important,
and leverage is also important. So all the three factors which can be important in any industry are also
important in airline industry. So that is why we can use ROE. But some people can oppose the above
discussed opinion, because Du Pont is not only one thig to focus because many other factors are also
important but the end of the day Du Pont also matter. So we can say that Du Pont can be use in an airline
industry.

(Q-6) How are financial ratios assessed? That is, how is the
information gained from the financial ratio analysis evaluated in order
to provide the most useful information.
We evaluate financial ratio analysis by comparison. For example, comparison with industry, comparison
with benchmark (company), comparison with competitors. Also, in totally we compare different ratios
with each other. As well as, we compare different ratios across different years.

(Q-7) In term of a time frame, is there a probable minimum number

of years or periods which would maximize the usefulness of ratio
analysis, particularly the DuPont method.
In comparison with yourself, Du Pont is useful if changes have occurred in each of these (Margin,
Turnover, Leverage) three things. If changes have occurred, then 5 years are good for assessment. The
dynamics of 5 years are very good to check that what changes have been made in margin, leverage &
Turnover as well as what are the structural changes have been made. On the other hand 🖐 , you can
also get your desire by comparing only your current year’s performance with other companies.