Map
Framework

DuPont decomposition of ROE

The question it answers

A CFO whose return on equity has risen has to tell the board whether margin, asset turnover or financial leverage is behind it.

Origin
Elliott & Elliott, 2019; Soliman, 2008
Diagram type
Hub diagram
Level of analysis
Firm
Topics
Corporate financeBusiness consulting
Stack of clay coins beside a rising glass bar chart, icon for finance

Diagram

DuPont decomposition of ROE

Operating ROE: operating profit / equity
Financial leverage: capital employed / equity
ROCE: operating profit / capital employed
Operating margin
Asset turnover: revenue / capital employed

Pitfalls

Pitfall
  • Ratios have no standard definition. Profit may be taken before or after interest and tax, and capital employed may be closing or average assets. Comparing two firms only means something on the same basis.
  • ROE rests on book values. If assets are carried below current value, ROE looks better than the economics.
  • Financial leverage can lift ROE without any operating improvement: more borrowing means a higher ROE and more risk. Look at ROCE on its own first.

Sources

References

Listed A–Z by author surname, Harvard style. A source with a DOI links to https://doi.org/…; one without links to its page or says plainly that it has no DOI.

  1. Elliott, B. and Elliott, J. (2019) Financial Accounting and Reporting, 19th edn. Harlow: Pearson.No DOISource page
  2. Soliman, M.T. (2008) ‘The use of DuPont analysis by market participants’, The Accounting Review, 83(3), pp. 823–853.doi:10.2308/accr.2008.83.3.823Source page