Chapter 4
Analysis of Financial
 Ratio Analysis
 DuPont System
Why are ratios useful?
Ratios standardize numbers and facilitate
Ratio comparisons should be made through
time and with competitors.
 Trend analysis.
 Peer (or industry) analysis.
Five Major Categories of Ratios and the
Questions They Answer
Liquidity: Can we make required payments?
Current ratio, Quick ratio.
Asset management: right amount of assets
vs. sales? Inventory Turnover
Debt management: Right mix of debt and
equity? Debt ratio, Times-Interest-Earned
Profitability: Gross Margin, Operating Margin
and Net Profit Margin.
Market value: Do investors like what they see
as reflected in P/E and M/B ratios?
Analysis of Income Statement
 Margin /Common Size
Gross Margin
Operating Margin
Research and Development
Sales and Administrative
Tax rate
Profit Margin
Income Statement
 Trend analysis
Margin comparison: are we becoming more
Growth rate: has the company been growing its
sales, Earnings? What is driving the growth? Is the
growth sustainable?
 Peer analysis
The Du Pont System
Objective: A set of manageable ratios leading
to maximize ROE
Why ROE: reward/investment; comparable
across industry
To increase ROE, lower Equity, higher NI,
Invest less(equity) but make more(NI)
However, lower equity is related to higher debt
and hence higher interest burden
NI—(from)Sales—(generated by)Assets—
(funded by) Equity
The Du Pont system
Du Pond Analysis can be expressed as:
ROE = (NI/Sales) x (Sales/TA) x (TA/Equity)
ROE = (Profit margin) x (TA turnover) x (Equity
Focuses on:
 Expense control (PM)
 Asset utilization (TATO)
 Debt utilization (Eq. Mult.)
Shows how these factors combine to determine ROE.
Some examples applying Du Pond system
 GE: 50% financed, TATO is 2, NI=1B, S=10B
what is ROE?
 Ford:
PM=5%, TATO=0.5 ROE=10%, what is
its capital structure?
DuPont equation: a real life example
Resource: http://finance.yahoo.com/
Decompose ROE of Ford
Compare with Microsoft