A Du Pont Model is sufficient and most suitable technique in understanding the Financial Performance of the company ABSTRACT:

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1 A Du Pont Model is sufficient and most suitable technique in understanding the Financial Performance of the company Prof. Laxman B. Doiphode 1, Dr. Y. S. Vaishampayan 2 ABSTRACT: Du Pont Model is method of performance measurement. Du Pont Corporation of US has developed this method in 1920s.According to this method assets are measured at their gross book value than at net book value which leads to higher return on equity (ROE). There are three things which affect ROE Operating efficiency, which is measured by profit margin? Asset use efficiency, which is measured by total asset turnover Financial leverage, which is measured by the equity multiplier. ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity). This system of analysis considers important interrelationships between different elements of financial statements. Most of the time investors do not prefer to highly profitable companies. They investigate the DuPont equation. Through DuPont analysis they see which types of companies are most fruitful for investor. They use two method of ranking, first one is base on profit (Net income) and second one is base on DuPont equation. Now the question is whether Du Pont model is sufficient and most suitable technique in understanding the financial performance of the company. Researcher has made effort to find out the efficiency and importance of the Du Pont model. He has made the comparison of Du Pont model with Cash Flow statement. Key words: Du Pont model, Cash Flow Statement, Financial leverage, ROE Introduction: Financial ratio analysis is. The analysis is (so adjustments might be required to obtain a fair picture of the facts) and the information should of the general business cycle, industry cycle, developments, practices and sensitivities to seasonality, firm specific changes, the type of the business and its products or services, etc. Financial ratio analysis can help to identify sources of weaknesses. However, the application. Simply aiming to maximize a ratio without being can be counterproductive with respect to other objectives. For instance, aiming to reduce working capital with the objective to minimize financing costs can cause sales and profitability to decline as the credit terms might constrain competitiveness This study tried to determine how Du Pont model is sufficient and most important techniques to analyse and understand the financial performance of the company. 286

2 Researcher has tried to find out correlations between the net income and cash flow from operating activity, the asset turnover and cash flow from investing activity, the leverage and cash flow from financing activity. The study concluded that Du Pont Analysis is made by calculating Net profit, Assets turnover and equity multiplier or ROE for the 20 companies chosen from three industries namely Airline, Aluminium and Cement industry, emphasize that absolute measurements are not relevant every time. Therefore, to have a common basis of comparison between several sets of data is necessary when calculating the ratio between effect and effort, but not relevant enough for connecting net profit margin with cash flow from operating activity, the asset turnover and cash flow from investing activity, the leverage and cash flow from financing activity. Review of Literature: The ratios provide an overview with respect to the financial statement of the company. They should be considered in the context of the respective industry. Although high ratios are typically desired, there are ad offs between optimizing the ratios and potentially neglecting asset investments to support future sales growth or a change in the capital structure can improve a ratio without the actually desired effect on performance. General objective to achieve production and operating efficiency, relative to respective industry competitors, it is important to assess the future profitability of the firm. The attainable of a company can be approximated by the return on equity (ROE) and the retention rate (RR);, whereby the RR = (1 payout ratio) = ( 1 dividends/net income) DuPont Analysis: Breaking ROE (= NI/Equity) up in individual components. Financial performance of any company indicates the competitive advantage of that particular company. If we separate the component of financial performance, we can understand competitive ability of the firm and Du Pont model assist to understand the financial performance in one snapshot. Many strategic researchers use the valuepricecost (VPC) model to define competitive advantage (e.g., Besanko, Dranove and Shanley, 1999; Ghemawat, 1991; Peteraf and Barney, 2003; Walker, 2004). The VPC framework is a bargaining power model: The price (P) is a bargaining result between the buyer, who receives a value (V) from the product, and the producer, who bears the cost (C) to produce that product (Hoopes, Madsen and Walker, 2003). The Du Pont analysis that is made (by calculating ROI and ROE) for the top 3 most profitable pharmaceutical companies in India emphasize that absolute measurements are not relevant every time. Therefore to have a common basis of comparison between several companies and to compose ranks the relative sizes for measuring efficiency are necessary when calculating the ratio. (S. Christina Sheela and Dr. K. Karthikeyan 2012) Having considered individual financial ratios as well as groups of financial ratios measuring shortterm liquidity, operating efficiency, capital structure and longterm solvency, and profitability, it is helpful to complete the evaluation of a firm by considering the interrelationship among the individual ratios. The DuPont equation ends up with ROE which is considered as the most important accounting ratio. (Florenz C. Tugas, 2011), The 2009 was a middle year which made investors to be unpredictable and to secure themselves as much as possible. In this year Investors took care about all the du Pont elements associated with all measured returns.in conclusion, the research is indicating the fact that Du Pont components represent an important and viable form of stock s abnormal returns analysis 287

3 which supports market participants in making their investment decisions (Marianna Botika,2012). Research Methodology: Total industries are four for this study and maximum five companies has been selected from each industry for the study. Profitable companies have been selected because hypotheses are based on profitability and high asset turnovers. Reason behind the selection of these listed companies for this study : 1) In these industries there is more number of companies, however only those companies have selected which are having better performance in terms of profitability and asset turnover over the last five years from the study of the year. 2) These selected companies have fulfilled the norms of (SEC), Securities Exchange Commission and listed on stock exchanges. 3) The companies from these industries have shown continuous growth and developments in all filed of business. 4) Companies from financial sector have not considered for this study because of the distinct norms and regulations. The present study was confined to the Further, data were supplemented with relevant information from various sources. Sampling Method: Non Probability sampling techniques which comprises purposive stratified technique has been chosen for this study. Tools Used in the Study: After formulation and tabulation of data researcher have used different statistical tests: For hypothesis researcher has used Z test and T test according to sample size (if sample is > 30 then Z test and if sample < 30 then T test). Then he has calculated descriptive statistics to know the variance for each variable and finally he has used Correlation statistics. The entire test has been done using MS Excel. Data Analysis: Hypothesis for the study: H1 : There is relationship between net profit margin and cash flow from operating activity H0: There is no relationship between net profit margin and cash flow from operating activity H2: There is relationship between asset turnover and cash flow from investing activity H0: There is no relationship between asset turnover and cash flow from investing activity H3: There is relationship between equity multiplier and cash flow from financing activity H0: There is no relationship between equity multiplier and cash flow from financing activity. 288

4 Flow of data analysis: Comparison between Du Pont Analysis & Cash Flow Statement: 1) Understandings from Cash Flow Statement: Cash Flow from Operating Activity: Operating Cash Inflow Revenue and Sales Operating Cash Outflow Operating Cost Can we relate this with Operating Efficiency i.e. Profitability or Profit Margin? General Assumption: To have more or high profitability, company need to increase sale and / or reduce the cost So, when there is increase in profit margin Sale / Revenue would have been increased which indicates operating cash inflow And when there is decrease in profit margin Sale / revenue would have been decreased which indicates nothing about operating cash flows. When there is increase in profit margin Cost might have decreased or reduced which indicates nothing about cash flows however, When there is decrease in profit margin Cost might have increased indicates operating cash outflow. Conclusion: When there is increase in profit margin indicates operating cash inflow and when there is decrease in profit margin indicates operating cash outflow. 2) Cash Flow from Investing Activity: Cash Inflow Sale of Assets, Interest and Dividend received Cash Outflow Purchase of Assets Can we relate this with Asset Turnover or Asset Utilization? General Assumption: To have a high Asset Turnover sales should increase and / or value of asset should decrease When there is increase in Asset Turnover Sales might have increased (value of asset is constant) indicates operating cash inflow When there is decrease in Asset Turnover Sales might have decreased (value of asset is constant) indicates nothing about cash flows 289

5 When there is increase in Asset Turnover Value of total asset might have decreased (value of sale is constant) indicates sale of assets showing cash inflow from investing activity. When there is decrease in Asset Turnover Value of total asset might have Increased (value of sale is constant) indicates purchase of assets showing cash outflow from investing activity. Conclusion: When there is increase in asset turnover indicates cash inflow from investing activity When there is decrease in asset turnover indicates cash outflow from investing activity. 3) Cash Flow from Financing Activity: Cash Inflow Raising funds through equity, preference share, debentures etc. Cash Outflow Repayment of loans, Interest and dividend payments. Can we relate this with Equity Multiplier OR leverage of the company? General Assumption: To have a low leverage or to minimize the risk (Ultimately to decrease equity multiplier) company should decrease value of total asset and / or increase the equity capital. (When there is increase in equity capital in the capital structure of the firm the value of debt will be decreased which ultimately showing low leverage (low risk company)) When there is decrease in Equity Multiplier Value of total assets might have decreased (value of equity capital is constant) indicates sale of assets ultimately showing cash inflow from investing activity When there is increase in Equity Multiplier Value of total assets might have increased (value of equity capital is constant) indicates purchase of assets ultimately showing cash outflow from investing activity When there is decrease in Equity Multiplier Value of equity capital might have increased (value of total asset is constant) indicates cash inflow from financing activity When there is increase in Equity Multiplier Value of equity capital might have decreased (value of total asset is constant) indicates buy back of shares ultimately showing cash outflow from financing activity Conclusion: When there is increase in equity multiplier indicates cash outflow from financing activity and When there is decrease in equity multiplier indicates cash inflow from financing activity. 290

6 List of Companies for this study: Airline Industry Aluminium Industry Cement Industry AAA Aviation Pvt Ltd. Alom Extrusions Ltd. ACC Ltd. Air India Charters Ltd. Amco India Ltd. Ambuja Cements Ltd. Air India Ltd. Bhoruka Aluminium Ltd. Gujarat Bitumen Ltd. Airbus India Operations Pvt Ltd. Bothra Metals & Alloys Ltd. Indian Hume Pipe Company Ltd. Airline Allied Services Ltd. Century Extrusions Ltd. JK Cement Ltd. Bajaj Aviation Pvt Ltd. Ess Dee Aluminium Ltd. JK Lakshmi Cement Ltd. Bangalore International Airport Ltd. Galada Power & Telecommunication Ltd. Mangalam Cement Ltd. Blue Dart Aviation Ltd. Global Vectra Helicorp Ltd. Ramco Industries Ltd. Cochin International Airport Ltd. Golkonda Aluminium Extrusions Ltd. Ultratech Cement Ltd. Global Vectra Helicorp Ltd. Gujarat Foils Ltd. HCC Aviation Ltd. Hind Aluminium Industries Ltd. Hindustan Aeronautics Ltd. Hindalco Industries Ltd. India International Airways Ltd. Indo Alusys Industries Ltd. Interglobe Aviation Ltd. Interglobe Aviation Ltd. Jagson Airlines Ltd. Jagson Airlines Ltd. Jet Airways (India) Ltd. Jet Airways (India) Ltd. Jet Lite (India) Ltd. Kingfisher Airlines Ltd. Karnavati Aviation Pvt Ltd. Maan Aluminium Ltd. Kingfisher Airlines Ltd. Manaksia Ltd. Ligare Aviation Ltd. National Aluminium Company Ltd. Mahindra Aerospace Pvt Ltd. Nirav Commercials Ltd. Mega Airways Ltd. Palco Metals Ltd. Pawan Hans Ltd. Parekh Aluminex Ltd. Punj Lloyd Aviation Ltd. PG Foils Ltd. Spicejet Ltd. Sacheta Metals Ltd. Swajas Air Charters Ltd. Spicejet Ltd. Taj Air Limited Sudal Industries Ltd. 1) Airline Industry : (i) Relationship between NPM CFOA Correlation NPM CFOA NPM 1 CFOA

7 Descriptive Statistics NPM CFOA Mean Mean Standard Error Standard Error Median Median 0 Mode #N/A Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 135 Count 135 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means CFOA NPM Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is no relationship between Net Profit Margin and cash flow from operating activity in airline industry. (ii) Relationship between ATR CFI Correlation ATR CFIA 292

8 ATR 1 CFIA Descriptive Statistics ATR CFIA Mean Mean Standard Error Standard Error Median Median 0 Mode 0 Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 135 Count 135 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means CFIA ATR Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is no relationship between Asset Turnover and Cash Flow from investing activity. (iii) Relationship between EM CFFA Correlation EM CFFA EM 1 CFFA

9 Descriptive Statistics EM CFFA Mean Mean Standard Error Standard Error Median Median 0 Mode #N/A Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 135 Count 135 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means CFFA EM Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail There is relationship between Equity Multiplier and Cash Flow from financing activity which we understand from Correlation test. However the association is very less between equity multiplier and cash flow from financing activity. Null hypothesis is accepted here because p value is greater than 0.05 and Z score is less than Z critical. 2) Aluminium Industry: (i) Relationship between NPM CFOA NPM CFOA NPM 1 CFOA

10 NPM CFOA Mean Mean Standard Error Standard Error Median Median Mode #N/A Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 145 Count 145 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means NPM CFOA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is relationship between Net Profit Margin and cash flow from operating activity in airline industry. However the association between two is very less. (ii) Relationship between ATR CFIA ATR CFIA ATR 1 CFIA

11 Descriptive Statistics ATR CFIA Mean Mean Standard Error Standard Error Median Median Mode #N/A Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 145 Count 145 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means ATR CFIA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is less association between Asset Turnover and Cash Flow from Investing activity. (iii) Relationship between EM CFFA EM CFFA EM 1 CFFA

12 Descriptive Statistics EM CFFA Mean Mean Standard Error Standard Error Median Median 0 Mode #N/A Mode 0 Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum 3303 Count 145 Count 145 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means EM CFFA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail There is relationship between Equity Multiplier and Cash Flow from financing activity which we understand from Correlation test. However the association is very less between equity multiplier and cash flow from financing activity. Null hypothesis is accepted here because p value is greater than 0.05 and Z score is less than Z critical. 3) Cement Industry : (i) Relationship between NPM CFOA Correlation NPM NPM 1 CFOA CFOA

13 Descriptive Techniques NPM CFOA Mean Mean Standard Error Standard Error Median Median Mode #N/A Mode #N/A Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 45 Count 45 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means NPM CFOA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is relationship between Net Profit Margin and cash flow from operating activity in airline industry. However the association between two is very less. (ii) Relationship between ATR CFIA 298

14 Correlation ATR CFIA ATR 1 CFIA Descriptive Statistics ATR CFIA Mean Mean Standard Error Standard Error Median Median Mode #N/A Mode #N/A Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 45 Count 45 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means ATR CFIA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail From the Z test null hypothesis is accepted (H0) and Using Correlation test, it is found that there is no relationship between Asset Turnover and Cash Flow from Investing activity. 299

15 (iii) Relationship between EM CFFA Correlation EM CFFA EM 1 CFFA Descriptive Statistics EM CFFA Mean Mean Standard Error Standard Error Median Median Mode #N/A Mode #N/A Standard Deviation Standard Deviation Sample Variance Sample Variance Kurtosis Kurtosis Skewness Skewness Range Range Minimum Minimum Maximum Maximum Sum Sum Count 45 Count 45 Confidence Level(95.0%) Confidence Level(95.0%) ztest: Two Sample for Means EM CFFA Mean Known Variance Observations Hypothesized Mean Difference 0 Z P(Z<=z) onetail z Critical onetail P(Z<=z) twotail z Critical twotail There is relationship between Equity Multiplier and Cash Flow from financing activity which we understand from Correlation test. However the association is very less between equity multiplier and cash flow from financing activity. Null hypothesis is accepted here because p value is greater than 0.05 and Z score is less than Z critical. 300

16 Conclusion: Researcher has studied all three industries. The study shows that there is no relationship between net profit margin and cash flow from operating activity, there is no relationship between asset turnover and cash flow from investing activity, there is no relationship between equity multiplier and cash flow from financing activity. Same result was found in all three industries. Sometimes the relationship between these variables found to be positive however there is very less association between them. References: 1) A Du Pont Analysis of the 20 Most Profitable Companies in the World,Michaela Herciu, Claudia Ogrean, Lucian Belascu,2010 International Conference on Business and Economics Research vol.1 (2011) (2011) IACSIT Press, Kuala Lumpur, Malaysia 2) THE DU PONT MODEL: EVALUATING ALTERNATIVE STRATEGIES IN THE RETAIL INDUSTRY,Philip L. Little, Coastal Carolina University Beverly L. Little, Horry Georgetown Technical College David Coffee, Western Carolina University, Academy of Strategic Management Journal, Volume 8, ) The use of Du Pont Analysis by market participants. Soliman, M. (2008). The Accounting Review Vol. 83, No pp ) Financial Performance of Pharmaceutical Industry in India using DuPont Analysis S. Christina Sheela 1* Dr. K. Karthikeyan 2, European Journal of Business and Management ISSN (Paper) ISSN (Online) Vol 4, No.14, ) The Structuring Research of Du Pont Analysis System Based on EVA Published in: Information Management, Innovation Management and Industrial Engineering (ICIII), 2010 International Conference on (Volume:3 ) 6) Evaluating the effect of recession on retail firms strategy using DuPont method: ( ) (i) Philip L. Little, Coastal Carolina University (ii) John W. Mortimer, Coastal Carolina University (iii) Marvin A. Keene, Coastal Carolina University (iv) Linda R. Henderson, Coastal Carolina University 7) CIME Industry Outlook 8) Moneycontrol.com A Du Pont Model is sufficient and most suitable technique in understanding the Financial Performance of the company ( * Prof. Laxman B. Doiphode) (**Dr. Y. S. Vaishampayan) 301