9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Akira, steps into your office and asked the following. AKIRA: Do you have 10 or 15 minutes that you can spare? YOU: Sure, I've got a meeting in an hour, but I don't want to start something new and then be interrupted by the meeting, so how can I help? AKIRA: I've been reviewing the company's financial statements and looking for ways to improve our performance, in general, and the company's return on equity, or ROE, in particular. Emma, my new team leader, suggested that I start by using a DuPont analysis, and I'd like to run my numbers and conclusions by you to see whether I've missed anything. Here are the balance sheet and income statement data that Emma gave me, and here are my notes with my calculations. Could you start by making sure that my numbers are correct? YOU: Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis. Balance Sheet Data Cash $1,300,000 Income Statement Data Sales $26,000,000 $1,560,000 Accounts payable Accruals 2,600,000 520,000 15,600,000 Accounts receivable Inventory Cost of goods sold Gross profit 3,900,000 2,080,000 10,400,000 7,800,000 4,160,000 6,500,000 Current assets Operating expenses EBIT 4,420,000 3,900,000 8,580,000 Notes payable Current liabilities Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity Interest expense 780,000 1,755,000 3,120,000 Net fixed assets 7,800,000 5,265,000 Taxes 780,000 Net income $2,340,000 Total assets $15,600,000 7,020,000 $15,600,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the total asset turnover ratio, and the And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company's effectiveness in using the company's assets, and Now, let's see your notes with your ratios, and then we can talk about possible strategies that will improve the ratios. I'm going to check the box to the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect. Canis Major Veterinary Supplies Inc. DuPont Analysis Value Correct/Incorrect Ratios Profitability ratios Value Correct/Incorrect Ratios Asset management ratio 40.00 Total assets turnover 12.00 1.67 Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 15.00 Financial ratios Equity multiplier 45.59 1.82 AKIRA: OK, it looks like I've got a couple of incorrect values, so show me your calculations, and then we can talk strategies for improvement. YOU: I've just made rough calculations, so let me complete this table by inputting the components of each ratio and its value: Do not round intermediate calculations and round your final answers up to two decimals Canis Major Veterinary Supplies Inc. DuPont Analysis Value Calculation Numerator Denominator Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Financial ratios Equity multiplier AKIRA: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Emma would have been very disappointed in me if I had showed her my original work. So, now let's switch topics and identify general strategies that could be used to positively affect Canis Major's ROE. YOU: OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company's ROE? Check all that apply. Use more debt financing in its capital structure and increase the equity multiplier. Decrease the company's use of debt capital because it will decrease the equity multiplier. Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company's total assets turnover. Decrease the amount of debt financing used by the company, which will decrease the total assets turnover ratio. AKIRA: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor