Chapter 2:

Evaluation of Financial
Performance

Du Pont Analysis
&
Types of Ratio Comparisons
Evaluation of Financial 1
Performance
 DU PONT Analysis
1. Act as a search technique , aimed at finding the
key areas responsible for the firm’s financial
condition
2. Used to analyze a firm’s profitability and ROE
3. Allows management to view more clearly what
determines or influences ROE and the
interrelationship between net profit margin,
asset turnover and debt ratio.
4. Breaks down ROE into 3 parts, that is, profit
margin, total assts turnover and financial
leverage.
5. ROE = NP margin x Total Asset turnover
(1 – Debt ratio)

= ROA/(1- Debt ratio)

Evaluation of Financial 2
Performance
 Du Pont Analysis
6. ROE = ROA x Total Assets
Total Equity
7. ROE = ROA x Equity Multiplier

Evaluation of Financial 3
Performance
 Equity Multiplier
• Measures a firm’s total assets per RM of
shareholders’ equity.
• Equity Multiplier = Total Assets
Total shareholders’ equity
• Indicates how a company uses debt in
asset financing
• A higher equity multiplier means higher
financial leverage

Evaluation of Financial 4
Performance
 How to improve the firm’s ROE
1. Increase sales without a disproportionate
increase in costs and expenses
2. Reduce the firm’s COGS or operating
expenses
3. Increase sales relative to the asset base or
decrease the amounts invested in the
company’s assets
4. Increase the use of debt relative to equity,
but only to the extent that it does not
jeopardize the firm’s financial position.

Evaluation of Financial 5
Performance
Advantages of DU PONT Analysis
• Makes it possible to assess all aspects of the
firm’s activities in order to isolate key areas
of responsibility
• Allows management to view more clearly
what drives the ROE
• Provides management with a road map to
follow in assessing their effectiveness in
managing the firm’s resources so as to
maximize the return earned on owners’
investment.

Evaluation of Financial 6
Performance
Types of Ratio Comparisons

• Trend Analysis

• Cross-Sectional Analysis

• Common-size Analysis

Evaluation of Financial 7
Performance
 Common Size Ratios
1. Also known as vertical analysis
2. Can be prepared from both income statement
and balance sheet
3. Each item on the financial statement is
calculated as percentage of the total.
4. Allows companies to compare performance from
period to period as well as from company to
company regardless of the size of the company.
5. To study trends with its own past financial
statement.
6. The objective is to understand why changes
have occurred and what to do in response.

Evaluation of Financial 8
Performance
THANK YOU

Evaluation of Financial 9
Performance