Tying the Ratios Together: The Du Pont Chart and Equation
Table 10-1 summarized MicroDrive’s ratios, and now Figure 10-2 shows how the re-
turn on equity is affected by asset turnover, the profit margin, and leverage. The chart
depicted in Figure 10-2 is called a modified Du Pont chartbecause that company’s
managers developed this approach for evaluating performance. Working from the
bottom up, the left-hand side of the chart develops the profit margin on sales.The var-
ious expense items are listed and then summed to obtain MicroDrive’s total cost,
which is subtracted from sales to obtain the company’s net income. When we divide
net income by sales, we find that 3.8 percent of each sales dollar is left over for stock-
holders. If the profit margin is low or trending down, one can examine the individual
expense items to identify and then correct problems.
The right-hand side of Figure 10-2 lists the various categories of assets, totals
them, and then divides sales by total assets to find the number of times MicroDrive
“turns its assets over” each year. The company’s total assets turnover ratio is 1.5 times.
The profit margin times the total assets turnover is called the Du Pont equation,
and it gives the rate of return on assets (ROA):
(10-1)
3.8%1.55.7%.
Net income
Sales
Sales
Total assets
ROAProfit marginTotal assets turnover
392 CHAPTER 10 Analysis of Financial Statements
FIGURE 10-2 Modified Du Pont Chart for MicroDrive Inc. (Millions of Dollars)
Multiplied by
Multiplied by
Return on Equity 12.7%
Return on Assets 5.7%
Total Assets Turnover 1.5
Depreciation
$100
Taxes
$78.3
Total Costs
$2,886.5
Interest plus
Preferred
Dividends $92
Other Operating
Costs $2,616.2
(Labor, overhead, etc.)
Subtracted
from
Sales
$3,000
Profit Margin: Earnings as a
Percent of Sales 3.8%
Divided
into
Net Income
$113.5
Sales
$3,000
Sales
$3,000
Divided
by
Fixed Assets
$1,000
Added
to
Cash and
Marketable
Securities $10
Accounts
Receivable
$375
Inventories
$615
Current Assets
$1,000
Total Assets
$2,000
Assets/Equity = $2,000/$896
= 2.23
388 Analysis of Financial Statements
