Return on Investment: Putting the DuPont Model into Practice

Transferring your hard-earned cash to anything other than your bank account can be a risky move. On the other hand, the risk of investing could also prove to be very lucrative. Risk refers to the range of possible outcomes of an activity. The wider the range of possible outcomes, the greater the risk. To determine whether or not to invest your money, you need to calculate the rate of return. The rate of return would tell you whether the investment is profitable or not. To calculate the rate of return you need to do the following:

Yield = Yield Amount / Amount Invested (Capital).

For example: let’s say you invest $100 in stocks called your equity. A year later, your investment returns $110. What is the return on your investment? It is calculated using the following formula:

((return – capital) / capital) × 100% = return

As a result: (($110 – $100) / $100) × 100% = 10%

Your return is 10%.

There are many financial metrics that are commonly used in the business world that are easy to get lost in the crowd. Using the DuPont model allows companies to break down the company’s profitability into its component parts to see where it’s actually coming from. The DuPont model is an important tool for companies to analyze their return on investment (ROI), or return on investment. The yield calculation is of particular importance as it ultimately describes the rate of return that a company can generate based on the assets it had available that year. The extension of the basic ROI calculation came in the late 1930’s by financial analysts at EI DuPont de Nemours & Co. The theory was put into practice when it was found that profitability from sales and the use of assets to generate revenue both important factors were evaluating the overall profitability of a company.

The more common variant of the ROI calculation looks like this:

Return on Investment = Net Income / Sales x Sales / Average Total Assets = ____%

First, look at the company’s ROI, which is: ROI = Net Income/Total Assets = _____%. Below are the steps using the DuPont model to calculate both the return on investment and the return on equity.

ROI = Net Income/ Average Total Assets = _____%. Net income is taken directly from the company’s income statement and average total assets from the company’s balance sheet. Ultimately, this ratio tells you how well you’ve used your assets to generate sales.

The percentage doesn’t really tell you much, but you can break the percentage down further to get valuable information. To do this, you need to use the DuPont model and decompose the ROI into its component parts. The ROI looks like this:

ROI = Net Income/Sales X Sales/Total Assets =

Within this equation, net income/sales is net profit margin and is taken from the income statement and sales/total assets is total assets turnover and sales is taken from the income statement and average total assets is taken from the balance sheet.

There are two parts to ROI: the company’s profit margin and asset turnover, or its ability to make profits and make sales based on its asset base. The extended DuPont model allows a company to study return on equity (ROE) in the same way.

ROE = Net Income / Average Owner Equity = _____%. Net income comes from the income statement and common equity is the sum of all equity accounts on the balance sheet.

It’s important to remember that ROI can be increased by doing one of the following: increasing sales and/or reducing expenses. The DuPont Model is an approach that allows managers to focus specifically on growing sales while controlling costs and being aware of the amount being invested in productive assets. A comprehensive financial statement analysis provides insight into a company’s performance and/or reputation in the areas of liquidity, operational efficiency and profitability. Time series analysis examines trends using the company’s own performance as a benchmark.