An Advanced Model for the Study of Profitability - Pt. 2
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In the 3rd level of depth of our Dupont tree , by multiplying the numerator and denominator of the ROA ( Net Result / Employments ) by the total Revenues, we will break it down into two further indices:
- Profit Margin ( Net Profit / Revenue ), a measure of the company's profitability, obtained by comparing the Net Profit with the Revenue (a Profit Margin of 10% means that the company makes a profit of 10 cents for every euro of turnover);
- the Turnover of the assets ( Revenues / Employments ), obtained by comparing the Revenues to the total Employments; it measures the efficiency of the company in the management of its assets , and in particular expresses the average revenue generated by each unit of capital invested in the business activity. The Turnover is expressed not as a percentage, but in the form of "number of times": a Turnover of 3.5 means that the invested capital "turns", or is able to return to liquid form due to the revenues deriving from sales, for 3.5 times.
At this level of analysis, therefore, the ROE will look like this:
3rd LEVEL OF ANALYSIS
That is, in terms of indicators:
ROE = Profit margin × Turnover × Equity Multiplier
At this level of depth, therefore, the ROE will be given by the product of the 3 indices described above, which represent:
- a profitability indicator (the Profit margin );
- an efficiency indicator (employment turnover );
- a leverage indicator (the Equity Multiplier).
In turn, pushing ourselves to a 4th level of depth, we could rewrite the Profit Margin in the following way:
in which:
So, to summarize, we will have:
4th LEVEL OF ANALYSIS
That is, in terms of indicators:
ROE = Fiscal Optimization × Financial Optimization × ROS × Turnover × Equity Multiplication
So we have managed to break down the ROE formula into a variety of indicators, each capable of telling us something about a particular area of management of the company.
In the 5th and final level of analysis, two of the elements thus obtained can be grouped into equally significant aggregates, as follows:
On the basis of these further breakdowns and re-aggregations, it is possible to calculate a further configuration for the ROE, in order to examine it even more in depth in its relationships with all the managements (therefore also operational, financial, extraordinary and fiscal) that characterise the business activity as a whole:
5th LEVEL OF ANALYSIS
That is, in terms of indicators:
ROE = Degree of Tax Optimization × ROI × Compound Leverage
After having seen in these two articles the five levels of ROE decomposition, in the third part of the article we will see a concrete example that highlights the possible uses of the Dupont scheme, and the considerable amount of useful information that we can easily obtain from its use.