DuPont Enterprise Financial Analysis
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Published: Wed, 20 Sep 2017
With the fast pace of modern society, the competitions between companies are becoming more fierce gradually. In order to catch the tide of financial progress, rational analyses are required for enterprise to understand a company’s financial situation and operational efficiency. As a result, entrepreneurs can judge their enterprises’ competitive position in the industry and sustainable development ability based on these analyses. DuPont analysis and factor analysis have been widely applied in enterprise financial analysis. Using these analysis methods can accurately calculate the various influence factors on the direction and extent of the influence of financial indicators, help enterprises to plan in advance, provide matter control and afterwards supervision, promote enterprises’ goal management and improve enterprise management level (Casella & Berger, 2002). Which analysis method is more informative for the analysis of corporate financial information? Admittedly, DuPont analysis plays a necessary role in financial analysis. While some experts are against this idea by claiming that factor analysis has a wider range of applications. This essay is aiming to explore the application of DuPont analysis methods in corporate financial management and whether this kind of analysis is more feasible than factor analysis in terms of enterprise development.
There is no doubt that DuPont analysis will be introduced to find its feasibility. Under the condition of considering the inner link of financial indicators, DuPont analysis uses the relationship between several major financial ratios to synthetically analyze the financial position of the enterprise. It is a classical method to evaluate the company profitability and shareholders’ equity returns level and evaluate enterprise performance from a financial perspective(Angelico & Nikbakht, 2000). The basic idea of DuPont analysis is to decompose the enterprise net assets yield to the product of a number of financial ratios, thus it can help to make an in-depth analysis of business performance. The most significant feature of DuPont model is to connect several ratios that are used to evaluate corporate efficiency and financial conditions according to their inner links, then form a complete index system, and finally reflect the enterprise by return on equity comprehensively (Angelico & Nikbakht, 2000). This method can make the level of financial ratio analysis more clear, organized and outstanding, to provide the operation and profitability of enterprises for financial statement analysts. DuPont analysis takes related values in place according to their inner links by DuPont chart and the core value is the return on equity. There are three key points that need to be noted when people utilize DuPont analysis (Bartholomew; Steele, et al, 2008): first, sales net interest rate reflects the relationship of net profit and sales income, and it depends on the sales revenue and total cost. Second, total assets can be referred as an important factor influencing asset turnover ratio and return on equity. Third, equity multiplier is influenced by asset-liability ratio index. To sum up, DuPont analysis system can explain the reason and trend of factor changes.
Though DuPont analysis has a lot of advantages and it’s widely applied, it also has some limitations. From the perspective of performance evaluation, DuPont analysis can only show financial information and cannot reflect the strength of enterprise (Harman, 1976). Primarily, DuPont analysis focuses on short-term financial results but ignore the long-term value creation. Moreover, financial indicators reflect the enterprise operating performance in the past, to measure industrial enterprises to meet the requirements of the times. But in the current information age, customers, suppliers, employees, technology innovators have more and more influence on the enterprise operating performance, and DuPont analysis is powerless in these aspects. In addition, DuPont analysis cannot solve the problem of intangible assets valuation that is very important to enhance the competitiveness of enterprises in a long term.
Despite all of these drawbacks, DuPont analyses are still the most prevalent tactics in enterprises around the world. The main reason is that enterprises nowadays combine classical DuPont analysis theories with the modern financial management goal. Enterprises design new DuPont analysis method based on the combination of the enterprise value maximization goal and the stakeholders’ interest maximization goal. In this way, stakeholders not only include the shareholders of an enterprise, but also consists creditors, business operators, customers, suppliers, employees and government. All these factors are essential for corporate financial management. The damage in either party of enterprise stakeholders’ interest is not conductive to the sustainable development of the company, also not conductive to reach the maximization of enterprise value. In other words, terminal aim of new DuPont analysis is within the framework of law and morality, under the premise of harmonious development, effectively balance the corporate stakeholders’ interest, realize the maximization of enterprise value. On the top that, new DuPont
However, factor analysis is feasible in the field that DuPont analysis cannot. Factor analysis is mainly used for determining the influence direction and degree of every factor in the total change in some kind of economic phenomenon affected by many factors (Bartholomew; Steele, et al, 2008). Factor analysis is the application and development of index method principle. It’s based on the index method principle. In the analysis of things change influenced by many factors, in order to observe the effects of some factors change, it will make other factors be fixed, and then analyze and replace item by item, so this method is also known as sequential substitution method (Harman, 1976). Based on comparative analysis, factor analysis is frequently used to find differences in the process of comparing and fatherly explore the cause (Larsen; Warne, 2010). Using factor analysis method, the first step is to study the formation process of the object and find various factors of analysis object; then to compare factors with the corresponding criterion item by item to determine the influence degree of differences of every factors, to help find the main contradiction and indicate the main direction of solving the problem for the next step. For instance, the relationship of a financial value and related factors can be represented as: Actual value: P1= A1xB2xC1; Standard value: P2=A2xB2xC2. The overall variance between the actual value and standard value is P1-P2, and it’s affected by three factors, namely A, B and C. The degree of influence of every factor can be calculated as: Influence of factor A: (A1-A2) xB2xC2; Influence of factor B: A1x (B1-B2) xC2; Influence of factor C: A1xB1x (C1-C2). Plus the above influence value, it is the overall variance: P1-P2. From the above analysis, it can be seen that factor analysis can be used for the detailed analysis of the degree of influence and can be more beneficial to guide the decision makers to find financial issues and propose solutions.
In conclusion, DuPont analysis and factor analysis have their own range of application. Through DuPont analysis system can provide better reasons and trends of financial index changes, factor analysis is better in enterprises’ financial analysis. Factor analysis can be used for more detailed analysis of the degree of influence and can be more beneficial to guide the decision makers to find financial issues ultimately and propose solutions fundamentally. In sum, factor analysis method has more extensive scope of application.
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