The Du Pont Chart
Chapter Twenty-Seven
Syllabus topic 1, "Ratio Analysis: Meaning, classification, Du Point Chart, advantages and limitations (Based on Vertical Form of Financial statements)"
Pages 72 to 74 of 162
In one line
The Du Pont chart splits the return on capital employed into a margin and a turnover, so that a change in the return can be traced to whichever of the two caused it.
The identity
Return on capital employed = (PBIT / Net sales) x (Net sales / Capital employed)
The net sales cancel, so the right side is PBIT over capital employed, which is the left side. The identity is true by construction, and that is its strength: it can never fail to reconcile, so a decomposition that does not multiply out has an arithmetic error in it.
| The two factors | Name | What it measures |
|---|---|---|
| PBIT / Net sales | Profit margin, or the net operating profit ratio on PBIT | How much of each rupee sold is kept |
| Net sales / Capital employed | Capital turnover | How many rupees of sales each rupee of capital produces |
Worked on Sunrise
| Rs | |
|---|---|
| Profit before interest and tax | 3,80,000 |
| Net sales | 20,00,000 |
| Capital employed | 19,00,000 |
Return on capital employed, computed directly.
| 3,80,000 over 19,00,000 times 100 | 20.00 per cent |
The same return, decomposed.
| Profit margin, 3,80,000 over 20,00,000 | 19.00 per cent |
| Capital turnover, 20,00,000 over 19,00,000 | 1.0526 times |
| Product, 19.00 times 1.0526 | 20.00 per cent |
The two agree, and they must.
Why the split matters
Because two companies can earn the same return by opposite means, and the management action needed is opposite too.
| Sunrise | A jeweller | A supermarket | |
|---|---|---|---|
| Profit margin, per cent | 19.00 | 40.00 | 4.00 |
| Capital turnover, times | 1.05 | 0.50 | 5.00 |
| Return on capital employed, per cent | 20.00 | 20.00 | 20.00 |
All three earn 20 per cent and none of them is in the same business. The jeweller makes its money on the margin and sells slowly; the supermarket makes almost nothing on each sale and sells its stock over and over. A jeweller trying to raise its return by selling faster is fighting its own model, and so is a supermarket trying to raise its margin.
This is what the chart is for: it tells a manager which of the two levers is available.
The chart, drawn out
The Du Pont chart is the identity drawn as a tree, with each factor broken down into the figures that make it.
| Level | Left branch | Right branch |
|---|---|---|
| Top | Return on capital employed, 20.00 per cent | |
| First split | Profit margin, 19.00 per cent | Capital turnover, 1.0526 times |
| Second split, left | PBIT Rs 3,80,000 over net sales Rs 20,00,000 | |
| Second split, right | Net sales Rs 20,00,000 over capital employed Rs 19,00,000 | |
| Third split, left | PBIT = gross profit 6,00,000 less operating expenses 2,40,000 plus net non-operating income 20,000 | |
| Third split, right | Capital employed = fixed assets 14,00,000 plus investments 1,00,000 plus working capital 4,00,000 |
The rest of this chapter
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The rest of this subject
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