CFA Level I Exam · Financial Analysis Techniques

DuPont Analysis and Profitability Ratios for CFA Level I

Updated 7 October 2026 · Fact-checked

Profitability ratios measure how much profit a firm earns from sales, assets and equity. DuPont analysis splits ROE into parts. The 3-step version is net margin × asset turnover × equity multiplier. The 5-step version splits net margin into tax burden, interest burden and EBIT margin. Multiply the parts to get ROE.

Understand Profitability Ratios and DuPont Analysis

Profitability ratios answer one question: how well does the company turn sales, assets and owners' money into profit? They fall into two groups. Return on sales ratios (margins) divide a profit measure by revenue. Return on investment ratios (ROA, ROE) divide a profit measure by the capital used.

Margins move down the income statement. Gross margin = (revenue − cost of goods sold) ÷ revenue. It shows pricing power and production cost. Operating margin = operating income ÷ revenue. It also deducts selling, general and administrative costs, so it shows the efficiency of the whole operation. Net margin = net income ÷ revenue. It also deducts interest and tax. A firm can have a high gross margin and a low operating margin if its overheads are heavy.

ROA = net income ÷ average total assets. ROE = net income ÷ average shareholders' equity. ROE is higher than ROA when the firm uses debt, because assets are larger than equity. That ratio of assets to equity is the equity multiplier (financial leverage).

DuPont analysis shows why ROE is what it is. The 3-step version: ROE = net profit margin × total asset turnover × equity multiplier. Profitability, efficiency and leverage each get one term. The 5-step version breaks net margin into three terms: tax burden (net income ÷ EBT), interest burden (EBT ÷ EBIT) and EBIT margin (EBIT ÷ revenue). The product is identical because the intermediate terms cancel.

Use it to compare firms or years. Two firms can both show ROE of 20%, but one gets it from strong margins and the other from heavy debt. The second is riskier. A falling tax burden or interest burden ratio means a higher tax rate or higher interest cost is pulling ROE down.

Key formulas to remember

Gross profit margin: (Revenue − COGS) ÷ Revenue; Measures production cost and pricing power.
Operating profit margin: Operating income ÷ Revenue; Deducts operating expenses as well as COGS.
Pretax margin and net profit margin: EBT ÷ Revenue; Net income ÷ Revenue; Net margin is after interest and tax.
Return on assets (ROA): Net income ÷ Average total assets; Use average assets unless the question says to use ending balances.
Return on equity (ROE): Net income ÷ Average shareholders' equity; Total shareholders' equity. Preferred dividends are handled in a separate measure, return on common equity.
Equity multiplier: Average total assets ÷ Average total equity; Higher value means more financial leverage.
3-step DuPont: ROE = (Net income ÷ Revenue) × (Revenue ÷ Average assets) × (Average assets ÷ Average equity); Net margin × asset turnover × equity multiplier. Also ROA = net margin × asset turnover.
5-step DuPont: ROE = (NI ÷ EBT) × (EBT ÷ EBIT) × (EBIT ÷ Revenue) × (Revenue ÷ Avg assets) × (Avg assets ÷ Avg equity); Tax burden × interest burden × EBIT margin × asset turnover × equity multiplier.
Return on total capital: EBIT ÷ (Short-term debt + Long-term debt + Equity); Measures return to all capital providers before interest and tax.

How to solve Profitability Ratios and DuPont Analysis questions

Use this method for any margin, return or DuPont question.

1Read what is asked: a single ratio, a full decomposition, or the reason ROE changed.
2List the figures given and decide which are income statement items (revenue, EBIT, EBT, net income) and which are balance sheet items (assets, equity).
3For return ratios, use average balances if both opening and closing figures are given. Use ending balances only if that is all you have.
4Write the formula before you put numbers in. For a decomposition, write each term with its numerator and denominator.
5Calculate each term, then multiply. Check that the product equals net income ÷ average equity.
6For 'why did ROE change' questions, compare each term between the two periods and find the term that moved most.
7Match the answer to the three options. Remove any option that is the margin, ROA or turnover left unmultiplied by leverage.

Quickest way: Cancel-and-check shortcut

When to use it: Use when the question gives you ROE, plus some components, and asks for a missing one, or when you must confirm a decomposition quickly.

Remember that every DuPont term is a fraction and neighbours cancel, so the product always collapses to net income ÷ equity.
If three of four terms in the 3-step are given with ROE, divide ROE by the known terms to get the missing one.
For the 5-step, find the unknown with ROE ÷ product of the four known terms.
On the BA II Plus, chain the terms in one line and keep full decimals in the interim terms; do not round them. For the first worked example, key: 70 ÷ 100 × 100 ÷ 120 × 120 ÷ 800 × 800 ÷ 500 × 500 ÷ 250 = 0.28 (chain left to right without rounding).
Sanity check: ROE must be greater than ROA if the equity multiplier is above 1.

Common mistakes in Profitability Ratios and DuPont Analysis

Using ending balances when the question gives opening and closing figures.
Students grab the last number in the balance sheet table.
Fix: Average the opening and closing totals for assets and equity unless the question says to use year-end figures.
Confusing gross margin with operating margin.
Both are margins, and both start with revenue.
Fix: Gross margin deducts only COGS. Operating margin also deducts operating expenses such as SG&A and depreciation.
Treating tax burden as the tax rate.
The word 'tax' suggests a rate.
Fix: Tax burden = NI ÷ EBT = 1 − tax rate. A tax burden of 0.70 means a 30% tax rate.
Mixing up interest burden with interest expense.
The name sounds like a cost, so a high number seems bad.
Fix: Interest burden = EBT ÷ EBIT. It is a fraction below 1 when there is interest expense, and a lower value means heavier interest cost.
Calling a higher ROE better without checking where it came from.
ROE is treated as a score.
Fix: Break ROE into its terms. If the increase came from the equity multiplier, the firm took on more leverage and risk, not better operations.
Using the wrong asset or equity base in the 5-step turnover and leverage terms.
Students switch between average and ending figures within one calculation.
Fix: Use the same basis in all terms so that intermediate values cancel and the product equals ROE.

Worked examples

Example 1

A company reports revenue of $800 million, EBIT of $120 million, interest expense of $20 million, tax of $30 million and net income of $70 million. Average total assets are $500 million and average equity is $250 million. Using the 5-step DuPont, ROE is closest to: A. 14.0%, B. 28.0%, C. 56.0%.

Show the solution

EBT = EBIT − interest = 120 − 20 = $100 million.
Tax burden = NI ÷ EBT = 70 ÷ 100 = 0.70.
Interest burden = EBT ÷ EBIT = 100 ÷ 120 = 0.8333.
EBIT margin = 120 ÷ 800 = 0.15.
Asset turnover = 800 ÷ 500 = 1.6.
Equity multiplier = 500 ÷ 250 = 2.0.
ROE = 0.70 × 0.8333 × 0.15 × 1.6 × 2.0 = 0.28.
Check: 70 ÷ 250 = 28%. Option A is ROA (70 ÷ 500), which ignores leverage.

Answer: B. 28.0%

Example 2

A firm has a net profit margin of 6%, an equity multiplier of 2.5 and an ROE of 18%. Its total asset turnover is closest to: A. 1.2, B. 3.0, C. 7.5.

Show the solution

Use the 3-step formula: ROE = net margin × asset turnover × equity multiplier.
0.18 = 0.06 × turnover × 2.5.
0.06 × 2.5 = 0.15.
Turnover = 0.18 ÷ 0.15 = 1.2.
Option B comes from dividing ROE by margin only (0.18 ÷ 0.06) and forgetting leverage. Option C (7.5) comes from multiplying ROE ÷ margin (3.0) by the equity multiplier instead of dividing.

Answer: A. 1.2

Exam tips

Questions are three-option MCQs. Compute the exact ratio, then pick the option; wrong options are usually a ratio with a step missing, such as ROA instead of ROE.
Watch the wording. 'EBIT margin' and 'operating margin' can differ if other income is included, so use the line item the question names.
In 'why did ROE change' items, compute only the terms you need. One term often explains the whole change.
Always check whether the question says average or year-end balances before you divide.
No marks are lost for wrong answers, so if time is short, eliminate the option that equals ROA or net margin and choose between the other two.

Practice questions from Financial Analysis Techniques

Profitability Ratios and DuPont Analysis in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Profitability Ratios and DuPont Analysis: frequently asked questions

What is the difference between 3-step and 5-step DuPont?

The 3-step splits ROE into net margin, asset turnover and equity multiplier. The 5-step splits net margin further into tax burden, interest burden and EBIT margin. Both give the same ROE, but the 5-step shows the effects of tax and interest.

How do I calculate ROE using the 5-step DuPont?

Multiply NI ÷ EBT, EBT ÷ EBIT, EBIT ÷ revenue, revenue ÷ average assets and average assets ÷ average equity. The result equals net income ÷ average equity. Use the same averaging basis for all terms.

What is the difference between gross margin and operating margin?

Gross margin = (revenue − COGS) ÷ revenue, so it only reflects production costs. Operating margin = operating income ÷ revenue, so it also deducts operating expenses such as SG&A. Operating margin is lower or equal to gross margin.

Should I use average or ending balances for ROA and ROE?

Use averages when you have opening and closing balances. Use ending balances only if the question gives only that figure or tells you to. Be consistent across all terms in a DuPont decomposition.