- In the area of financial ratios,
the DuPont framework might be
the most well known ratio there is.
Over 100 years ago, an accountant at DuPont
F. Donaldson Brown created a way for a company
to compare operating performance
in various different divisions.
DuPont was a vertically integrated company
and management often had to compare
really different projects.
Mr. Brown created a financial ratio analysis framework
that combined measure of profitability,
efficiency, and leverage into one overall measure
of performance that allows comparisons in performance
across divisions within a company,
and even across companies.
Now the DuPont framework has three components,
profitability, efficiently, and leverage.
Let's start with leverage,
because that's the first thing that we do.
When it comes to leverage,
that's an indication of how much money
have we borrowed to purchase assets?
Now, why do we purchase assets?
Well we purchase assets in hopes of generating more sales.
The leverage measure tells us,
of our assets, how many were acquired with the equity
that's been put into the business.
We've borrowed to buy, it gives us a measure of how much
we've borrowed to buy assets
and again, why do we buy assets?
To generate sales,
that's what the efficiency ratio is measuring.
We buy assets to generate sales.
The more sales we can generate per dollar of assets,
the better.
Now why do we want sales?
Well that leads us to our profitability measure.
The more sales we have, the higher our income's going to be.
So first of all, we borrow money to buy assets,
we buy assets to generate sales,
we generate sales to generate income.
Our return on equity measure tells us
how much income did we generate given a fixed amount
of stockholders equity that's been invested
by the owners in the firm.
Now with that framework,
let's take a look at uncertain versus benchmark
using the DuPont framework to identify
not only how uncertain is done
but why they are perform poorly relative to benchmark.
So we can see the two companies return on equity
and the DuPont framework analysis is here.
Uncertain with 9.3% return on equity,
benchmark with 20.3%.
And we can also see the profitability measures,
the efficiency measures,
and the leverage measures for uncertain and benchmark.
To review, we look at leverage,
efficiency, and profitability
for uncertain and benchmark
and the first thing we notice is that leverage is the same
for both companies.
So in explaining the difference in return on equity
between uncertain and benchmark,
it can't be attributed to leverage.
So then we look at efficiency.
And we find out that uncertain generates $1.38
in sales for every dollar worth of assets,
compared to benchmark which generates $1.70 in sales
for every dollars worth of assets it has.
Then we look at profitability,
when it comes to profitability,
uncertain is generating $3.50 in profit
for every one hundred dollars in sales,
compared to benchmark which is generating $6.20 in profit
for every one hundred dollars in sales.
So why is benchmarks return on equity
so much higher than uncertain's?
Well it's profitability and efficiency.
Benchmark is much better at generating sales with its assets
and generating earnings with its sales.
So now do we have any other questions?
Well, when it comes to efficiency,
which specific assets are being used
inefficiently by uncertain?
When it comes to profitability,
which expenses are too high,
which would account for their lower profitability?
We want to know the answer to those questions
and we would do that with further analysis.