9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Landon, steps into your office and asked the following. LANDON: 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? LANDON: 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. Amelia, 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 Amelia 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 Income Statement Data Cash $700,000 Accounts payable Sales Accounts receivable $840,000 280,000 $14,000,000 7,000,000 1,400,000 Accruals Cost of goods sold Balance Sheet Data Income Statement Data Accounts payable Accruals Cash $700,000 Accounts receivable 1,400,000 Inventory 2,100,000 Current assets 4,200,000 Notes payable Current liabilities Long-term debt Total liabilities $840,000 280,000 1,120,000 2,240,000 3,640,000 5,880,000 980,000 2,940,000 3,920,000 $9,800,000 Sales $14,000,000 Cost of goods sold 7,000,000 Gross profit 7,000,000 Operating expenses 3,500,000 EBIT 3,500,000 Interest expense 571,200 EBT 2,928,800 Taxes 732,200 Net income $2,196,600 Net fixed assets 5,600,000 Common stock Retained earnings Total equity Total debt and equity Total assets $9,800,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the the total asset turnover ratio, and the gross profit margin And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratio net profit margin 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. Hydra Cosmetics Inc. DuPont Analysis Value Correct/Incorrect Value Correct/Incorrect Ratios Asset management ratio Total assets turnover 50.00 1.43 Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 20.92 22.41 Financial ratios Equity multiplier 53.52 1.67 LANDON: 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. Calculation Value 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 LANDON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassmenti Amelia 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 Hydra'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. 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. Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin. Decrease the company's use of debt capital because it will decrease the equity multiplier. Use more debt financing in its capital structure and increase the equity multiplier. LANDON: 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. 9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Landon, steps into your office and asked the following. LANDON: 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? LANDON: 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. Amelia, 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 Amelia 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 Income Statement Data Cash $700,000 Accounts payable Sales Accounts receivable $840,000 280,000 $14,000,000 7,000,000 1,400,000 Accruals Cost of goods sold Balance Sheet Data Income Statement Data Accounts payable Accruals Cash $700,000 Accounts receivable 1,400,000 Inventory 2,100,000 Current assets 4,200,000 Notes payable Current liabilities Long-term debt Total liabilities $840,000 280,000 1,120,000 2,240,000 3,640,000 5,880,000 980,000 2,940,000 3,920,000 $9,800,000 Sales $14,000,000 Cost of goods sold 7,000,000 Gross profit 7,000,000 Operating expenses 3,500,000 EBIT 3,500,000 Interest expense 571,200 EBT 2,928,800 Taxes 732,200 Net income $2,196,600 Net fixed assets 5,600,000 Common stock Retained earnings Total equity Total debt and equity Total assets $9,800,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the the total asset turnover ratio, and the gross profit margin And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratio net profit margin 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. Hydra Cosmetics Inc. DuPont Analysis Value Correct/Incorrect Value Correct/Incorrect Ratios Asset management ratio Total assets turnover 50.00 1.43 Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 20.92 22.41 Financial ratios Equity multiplier 53.52 1.67 LANDON: 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. Calculation Value 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 LANDON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassmenti Amelia 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 Hydra'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. 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. Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin. Decrease the company's use of debt capital because it will decrease the equity multiplier. Use more debt financing in its capital structure and increase the equity multiplier. LANDON: 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