DuPont analysis of return on equity

DuPont analysis breaks return on equity into three ratios multiplied together: net profit margin, asset turnover and an equity multiplier that measures gearing. Because the three multiply back to profit divided by equity, any change in return on equity can be traced to pricing and cost control, to how hard the assets are worked, or to how much of the business is funded by debt.

How does the three step formula work?

Return on equity (ROE) is profit after interest and tax divided by total equity, the definition used in ACCA’s guidance on ratio analysis. DuPont analysis writes it as:

ROE = (Profit ÷ Revenue) × (Revenue ÷ Total assets) × (Total assets ÷ Equity)

• Net profit margin (profit after tax ÷ revenue): how much of each pound of sales is kept as profit.
• Asset turnover (revenue ÷ total assets): how much revenue the asset base generates.
• Equity multiplier (total assets ÷ equity): how many pounds of assets each pound of equity supports. The more debt, the higher it is.

Revenue and total assets cancel out, leaving profit ÷ equity. The value of the method is not the answer, which is the same as calculating return on equity directly, but the explanation it gives.

How does it relate to return on capital employed?

ACCA’s guidance shows the same idea one level up: return on capital employed equals operating profit margin multiplied by asset turnover, where asset turnover is revenue ÷ capital employed. Its example is a 5% margin and asset turnover of 2 giving ROCE of 10%, and it stresses this means any change in ROCE can be explained by a change in margin, in asset turnover, or both. ACCA’s performance appraisal article adds a caveat: the identity only holds when operating profit equals profit before financing and tax, so investment income must be stripped out first.

DuPont analysis goes one step further by adding the financing effect. A five step version separates the profit margin into three parts:

1. tax burden: profit after tax ÷ profit before tax;
2. interest burden: profit before tax ÷ operating profit;
3. operating margin: operating profit ÷ revenue;
4. asset turnover: revenue ÷ total assets;
5. equity multiplier: total assets ÷ equity.

The five step version shows the cost of gearing (interest burden) next to its benefit (equity multiplier), which the three step version hides. See return on capital employed for the operating view.

What does a worked example look like?

Illustration only. Two companies each earn ROE of 15%.

Measure	Company A (retailer)	Company B (engineering)
Revenue	£10.0m	£4.0m
Profit after tax	£0.3m	£0.6m
Total assets	£4.0m	£8.0m
Equity	£2.0m	£4.0m
Net profit margin	3%	15%
Asset turnover	2.5	0.5
Equity multiplier	2.0	2.0
ROE	3% × 2.5 × 2.0 = 15%	15% × 0.5 × 2.0 = 15%

Same return, very different businesses. Company A depends on volume, so a one point fall in margin costs it a third of its ROE. Company B depends on pricing and on using expensive assets fully. ACCA notes that a high asset turnover commonly goes with a low return on sales and vice versa, and that retailers generally have high asset turnover and low margins.

What does each component tell you?

Margin

ACCA explains that weak operating margins are often caused by prices that are too low or costs that are too high, and suggests linking movements back to gross margin. See net profit margin.

Asset turnover

ACCA’s performance appraisal article points out how events distort this ratio. A revaluation increases the asset base and reduces asset turnover with no change in operating capacity. A major asset purchase late in the year reduces it because the asset has not yet contributed a full year’s revenue. A disposal increases it. See asset turnover.

Equity multiplier

This is gearing in another form. ACCA notes that borrowed capital is attractive because lenders accept a lower return than shareholders and interest is tax deductible, but that interest and repayments are legal obligations whereas dividends are not. A rising multiplier lifts ROE while profits hold up and magnifies losses when they fall.

How does gearing flatter return on equity?

Illustration only. If Company B borrowed £2m to buy back half its shares, equity would fall to £2m and the multiplier would rise to 4.0. Even after interest reduced profit to, say, £0.5m, ROE would be 25%. Nothing about the underlying business has improved; shareholders are simply carrying more risk. This is why DuPont analysis should always be read with the gearing ratio and interest cover. ACCA describes interest cover of more than three as usually considered safe.

Which accounting choices distort the components?

• Lease accounting. The IASB’s effects analysis for IFRS 16 expected asset turnover to fall and gearing to rise once leases were brought onto the balance sheet. The FRC’s Periodic Review 2024 amendments do the same for FRS 102 for accounting periods beginning on or after 1 January 2026, so a comparison across that date will show lower asset turnover and a higher equity multiplier with no real change.
• Revaluations increase both assets and equity, reducing asset turnover and the multiplier.
• Opening, closing or average balances. Use averages for a growing business and be consistent.
• Owner remuneration. In a small company the split between salary and dividends changes reported profit and therefore margin; see salary versus dividends.
• Negative or tiny equity makes the multiplier meaningless.

What mistakes come up most often?

• Mixing definitions, for example operating profit in the margin but profit after tax in ROE, so the components no longer multiply to the total.
• Using capital employed in one ratio and total assets in another.
• Reading a higher ROE as better without checking whether it came from the equity multiplier.
• Comparing companies in different sectors without allowing for the margin and turnover trade off.
• Explaining a movement without saying why it happened, which ACCA’s guidance criticises as rote learning. See limitations of ratio analysis.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

Related Accountapedia entries

• Horizontal and vertical analysis
• Gross profit, operating profit and net profit
• Interest cover
• How the new lease rules affect EBITDA and covenants
• IFRS 16 leases overview

Sources

• ACCA: Ratio analysis
• ACCA: Performance appraisal
• IFRS Foundation: Ifrs16 effects analysis
• Financial Reporting Council: FRS 102 September 2024 tmKYWO6

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.