The formula on return on equity.

The formula is basically talking about return on equity, but it has divided return on equity into three parts. When you are computing return on equity, you are not doing it by equity. When you are doing DuPont analysis, you are looking at the return on equity level at three different levels. At the time of computing return on equity, you will multiply net profit margin with asset turnover ratio with equity multiplier. The net profit margin or asset turnover ratio or equity multiplier is replaced with net formula. The formula of ROE is PAT divided by net worth. The formula of net profit margin is PAT divided by sales. We will multiply the formula of asset turnover ratio i.e. sales divided by total assets. And the formula of equity multiplier is total assets divided by net worth. If you know a little about maths, you will understand. When we do multiplication, sales will be cancelled along with total assets. Sales in net profit margin is in denominator and sales in asset turnover ratio is in numerator. So, the sales of numerator and denominator will be cancelled. And the total assets in asset turnover ratio and equity multiplier will be cancelled in front of you. And you will have Pat divided by net worth, which is nothing but ROE. The formula of ROE is written on the left side. The formula of ROE will remain the same on the right side after all the cancellation. It is called synthesis. It is called divide. We have distributed it in parts. So that when we calculate ROE, we can see that at different levels, i.e. profit level or allocation of assets or utilisation of assets. 

And net worth, i.e. the shareholder of the company, how did ROE perform its assets in front of it? 

So, the company's CFO will see that ROE has come out this much. But how much has the net profit margin company earned? So, how much profit has been earned in front of the sales? After that, he will also see that the total assets we deployed in the company, how many sales have been generated in front of it. Then he will also see that the net worth, i.e. the equity that the equity shareholders applied, how many total assets have been bought in front of it. Look, here it also happens that you do not buy assets only from net worth. That is, you do not buy the portion of equity from the shareholders. When you buy total assets, at that time, the shareholder likes it. At the same time, the money is also in the form of debt. i.e. whatever capital you generate from equity plus debt, whatever capital you raise, you buy assets from it. I had already discussed about this. When you buy assets, then you buy extra assets, do some investments and keep money for the working capital. So, this money does not come from equity only. If a company is raising money only from equity, or the equity capital is investing only in the company, this is also raising debt capital along with the wrong equity. We have simplified it a little more. ROU is equal to net profit divided by equity, which is your standard formula. Equal to net profit divided by sales, into sales divided by assets, into assets divided by equity. As I said, you will cancel it. Ultimately, your net profit divided by equity will remain standard formula only. Let's ask a basic question on this. There was no question on profitability ratio because it is quite simple. But you need to understand this here. So, we have made a question about this. 

You have net profit as the revenue of 5 lakhs. Sales is of 50 lakhs, total assets is of 55 lakhs. And shareholder's equity is of 10 lakhs. We are computing it according to the DuPont analysis. In step 1, we will compute net profit margin. 5 lakhs divided by 50 lakhs multiplied by 100. That is 10%. In the second step, we will calculate turnover ratio. We will take your revenue, that is, sales divided by total assets. That is 50 lakhs divided by 25 lakhs. And that is 2 times. In the third step, we will compute equity multiplier. What will you take here? 

Total assets. And you will divide shareholder's equity, that is 10 lakhs, which is 2.5 times. Now, we will multiply it according to the DuPont analysis. Net profit margin multiplied by asset turnover ratio multiplied by equity multiplier. That is 10 into 2 into 2.5. And what is coming out is 50%. If you calculate it in the ROE standard way, that is net profit 5 lakhs. Divided by shareholder's equity, 10 lakhs multiplied by 100. The answer will be 50% here. Let's understand this in more The net profit margin here is 10%. Now, can you compare it? Yes, you can compare it at two levels. There will be a self-comparison. You can compare it with your past performances, past year profits. If it is 12%, 15%, 18%, then you can see that ROE is 50%. But our net profit margin has reduced. Is it possible or not? Secondly, there can be a comparison with the peer group. That is, your competitors. You can compare it with them. How much is their ROE? Their ROE is 50%. But their net profit margin is 18% or 16%. So, there is a decrease here. So, you can't do this here. ROE can be good. But your net profit margin is here. So, it is necessary to work here. Second is the asset turnover ratio. That is, how much assets you have invested here, 25 lakhs. And how much revenue you have generated in front of it. The more revenue you generate, the better it will be. That is, it will be 4 times, 5 times, 2.5 times. The higher, the better. It is going to be the indicator over here. Again, you can compare it with yourself and your peer group. And in the third step, let's talk about the equity multiplier. Here, the issue is that equity from the shareholder is 10 lakhs. When the shareholder invests 10 lakhs, 25 lakhs assets will be bought in front of it. Now, how will these 25 lakhs assets be bought? The money is worth 10 lakhs. That is, your leverage will be generated here. That is, you will take the debt here. The more it is, the more burdensome it will be for the company. Here, it is 2.5 times. You can see in your past performance, how equity multiplier is in the past years. At the same time, you can compare it with your peer group. But the less it is, the better it will be. So, the profit margin should be more. The asset turnover should also be more. And the equity multiplier should be less. So, here RO is very attractive. But the individual components here are better. You can compare it with your past performance. So, I think you must have understood the DuPont analysis here. Or as I have said, you also have a detailed video. The link is given in the description box. You can see that too. This will give you a little more understanding. So, I hope you understood all the formulas and parameters. Thanks for your time and happy learning.