Financial Accounting: An Integrated Statements Approach, 2nd Edition

MARGIN ANALYSIS AND ASSET

EFFICIENCY ANALYSIS

In the previous section, we noted that Pixaris earning 12.4% on its assets, while

DreamWorksis earning 35.4% on its assets. In this section, we will more precisely ex-

plain this difference. The rate earned on total assets is the product of a firm’s profit

margin and the efficiency by which it uses its assets, as shown in Exhibit 5. One way

to summarize this relationship is the DuPont formula. The DuPont formula, created

by a financial executive of E.I. DuPont De Nemours & Co.in 1919, states that the rate

earned on total assets is the product of two factors, the profit margin and the total as-

set turnover, shown as follows:

Rate Earned on Profit

Total Assets



Margin

 Asset Turnover

Net Income



Net Income



Net Sales

Average Total Assets Net Sales Average Total Assets

The first factor is the ratio of net income to net sales (or revenues), often called the

netprofit margin. The profit margin shows the profit earned as a percent of sales. The

second factor is the ratio of net sales to average total assets, or the asset turnover.

The asset turnover is the number of sales dollars earned for each dollar of total assets.

The “profit machine” shown in Exhibit 6 illustrates the DuPont formula. Profits are

earned by either increasing the profit margin (increasing the size of the opening) or

increasing the asset turnover (turning the crank faster) or both.

The DuPont formula for Pixar and DreamWorks, with 2004 net sales for

DreamWorks of $1,078.2, is as follows:

Rate Earned

on Total Assets  Profit Margin  Asset Turnover

Pixar 12.4%  51.8%b  0.24c

DreamWorks 35.4%a  30.9%d  1.15e

aSmall differences in multiplication may occur due to rounding.

b$141.70/$273.50 c$273.50/$1,138.50

d$333/$1,078.20 e$1,078.20/$940.70

640 Chapter 14 Financial Statement Analysis

Analyze the rate earned

on total assets by evaluat-

ing the profit margin and

the asset efficiency of a

business.

3

Exhibit 6

The “Profit Machine”

Theasset turnover

indicates the rate

of sales on each dollar

of invested assets.

Theprofit margin

indicates the rate of profit

on each revenue dollar.

Revenues

Profit

The “Profit Machine”