ACC501 - Business Finance GDB 04-06 , 2013

ACC501 - Business Finance
Graded Discussion Board
December 04-06 , 2013


The DuPont identity or model of financial statement analysis was developed by F. Donaldson Brown. He joined the huge chemical company's reserves department in 1914 and then he developed a model for planning and controlling inventories. Afterwards, this model was used frequently for financial statement analysis as well. It is claimed that Du Pont analysis is the best analysis, which can be used for the measurement of overall performance of financial statements of any firm.

There are two different opinions regarding the application of Du Pont model. One of them states that it is not the best tool for analyzing financial statements while the other considers this model as the best one for the said purpose.

As a student of “Business Finance”, which of the above mentioned opinions you would support? Whether Du Pont Model is the best technique for the financial statement analysis or not? Support your arguments with conceptual rationale in either case.

solution:

The DuPont Identity is important because it helps an analyst understand what is driving a company's ROE; profit margin is a reflection of operating efficiency; asset turnover is a reflection of the efficient use of assets; and leverage shows how much a firm relies on debt to drive profitability.
The method recognizes that in addition to profitability, it is also important to understand how efficiently a company's assets generate sales or cash and how well a company uses debt to produce incremental returns.
[b]Using these three factors, a DuPont identity allows analysts to dissect a company, efficiently determine where the company is weak and strong and quickly know what areas of the business to look at (i.e., inventory management, debt structure, margins) for more answers. The measure is still broad, however, and is not a substitute for detailed analysis.[/b]
[b][b]It is important to note that DuPont identities use both balance sheet measures (which are calculated at a fixed point in time) and income statement measures (which encompass an interval of time). As a result, major asset purchases, acquisitions, or other significant changes can distort the ROE calculation. Many analysts use average assets and shareholders' equity to mitigate this distortion, although that approach assumes the balance sheet changes occurred steadily over the course of the year, which may not be accurate either.[/b][/b]