Profitability: how much the company earns on its resources
Profitability ratios relate profit to the resource base that generated it. They answer the question: how efficiently does the company turn capital into profit? To avoid distortions, the denominator usually uses average values for the period, because profit builds up over the whole year.
The DuPont breakdown
A high ROE can come from very different sources: high margins, intensive use of assets or high leverage. The DuPont breakdown separates these three sources.
Leverage and solvency
- Financial debt/equity — how much the company relies on creditors relative to shareholders.
- Net debt — financial debt minus cash; later used to calculate enterprise value.
- Interest coverage ratio — how many times operating profit covers interest expense.
- Current ratio — current assets relative to current liabilities, an indicator of short-term ability to pay.
There are no universal thresholds: a utility with stable revenue can sustain higher leverage than a cyclical company. The trend over time and the comparison with similar companies are more informative than a single value in isolation.
Financial leverage works in both directions. As long as the return on assets exceeds the cost of debt, borrowing increases shareholder returns. When operating profit falls or interest rates rise, the same debt amplifies the decline in ROE and can put pressure on liquidity, especially if loan maturities are concentrated in a short period.
An integrated example
| Nistru Agro SA (MDL thousand, illustrative) | Beginning of year | End of year | Average |
|---|---|---|---|
| Total assets | 52,000 | 60,000 | 56,000 |
| Equity | 23,960 | 30,000 | 26,980 |
| Financial debt (loans) | — | 22,000 | — |
| Cash | 2,000 | 2,300 | — |
Interpretation: the ROE of about 26% is supported by a solid net margin, but also by an equity multiplier of roughly 2.1. Interest coverage of 5 times provides a reasonable safety margin: EBIT could fall by 80% before interest would no longer be covered by operating profit.
Key takeaways
- ROE, ROA and net margin measure how efficiently the company turns resources into profit.
- The DuPont breakdown shows whether ROE comes from margins, asset turnover or leverage.
- The debt ratio and interest coverage measure the financial risk the company takes on.
- Values must be interpreted in context: sector, multi-year trend and comparable companies.
Check your knowledge
Answer all the questions. If you answer all of them correctly, the lesson is marked as completed automatically.
Explanation: A higher equity multiplier means a larger share of assets is financed with debt, so B's ROE depends more on leverage.
Explanation: Interest coverage = EBIT ÷ interest = 10,000 ÷ 2,000 = 5.0.
Explanation: Profit is a flow measured over a period, while equity is a stock measured at a point in time; the average approximates the capital employed over the whole period.
Educational material only. It does not constitute investment, legal or tax advice. Numerical examples are hypothetical.