Net profit margin falls from 10.40% to 9.92%, yet return on equity rises from 40.78% to 41.33%. Does the business operate better, or is something else lifting the return?
Both can happen in the series' hypothetical company. ROE combines profit margin, the sales produced from assets, and assets relative to equity. A DuPont breakdown shows how each part moves before we ask what caused it in actual operations.
The example sells equipment, installs systems, and provides continuing support. Amounts are THB millions; years 1 (Y1) and 2 (Y2) each cover 12 months. It has no preferred shares or noncontrolling interests, so all net profit belongs to common shareholders under the assumptions.
Define ROA and ROE consistently first
Here, ROA = net profit ÷ average total assets, while ROE = net profit attributable to common shareholders ÷ average common equity. Both are returns based on accounting figures for the period.
Other reports may define ROA with a different profit numerator, so check it before comparison. Net profit is after interest and tax; NOPAT is after-tax operating profit used in the RNOA article. They answer different questions.
The example averages opening and closing balances. Revenue and profit accrue over a year, but assets and equity are measured at dates. The average better aligns the ratio base with the earnings period, although two points still miss within-year swings.
| Item | Y1 | Y2 |
|---|---|---|
| Net profit | 10.40 | 12.40 |
| Opening total assets | 55.00 | 64.00 |
| Closing total assets | 64.00 | 81.00 |
| Average total assets | 59.50 | 72.50 |
| Opening equity | 25.00 | 26.00 |
| Closing equity | 26.00 | 34.00 |
| Average equity | 25.50 | 30.00 |
| ROA using net profit | 17.48% | 17.10% |
| ROE for common shareholders | 40.78% | 41.33% |
Why split ROA into profit and asset use?
ROA gives an overall return but not whether the next investigation belongs in profit per sale or asset use. Split it into net profit margin × total asset turnover and the questions sharpen. If margin thins, inspect price, cost, and work mix. If sales per unit of assets fall, ask which resources are waiting, supporting growth, or not yet earning as planned.
The decomposition helps diagnosis and management choices, but assets improve through what teams do next: resolve receivables disputes, reduce stock with no use plan, or repair frequently stopped equipment. A ratio does not create quality by itself. If turnover rises, still test whether profit is sufficient, cash supports the work volume, and delivery quality meets the agreement.
Lower prices with volume, or higher prices with more profit per sale
Separate from the main series company, suppose two alternatives over equal 12-month periods. A charges less and sells more units; B charges more and sells fewer. Both use THB 10 million in average total assets and earn THB 1 million net profit. Holding the asset base equal isolates the effect of margin and turnover.
| Item and unit | A: lower price, higher volume | B: higher price, higher margin |
|---|---|---|
| Price per unit (THB) | 500 | 1,000 |
| Units sold during the year | 40,000 | 10,000 |
| Revenue (THB millions) | 20.0 | 10.0 |
| Total expenses at all levels, including assumed interest and tax (THB millions) | 19.0 | 9.0 |
| Net profit (THB millions) | 1.0 | 1.0 |
| Average total assets (THB millions) | 10.0 | 10.0 |
| Net profit margin | 5.0% | 10.0% |
| Total asset turnover | 2.0 times | 1.0 time |
| ROA = net profit margin × asset turnover | 5.0% × 2.0 = 10.0% | 10.0% × 1.0 = 10.0% |
Both have the same ROA, but that does not establish equal risk, cash, quality, or business value. Volumes are assumed. A higher price does not automatically slow sales or reduce units sold. “Selling faster” in the volume strategy means more sales through the asset base during the period. It does not mean collecting from customers faster. Price does not determine DSO automatically; read credit and collection terms separately.
What difference gives customers a reason to choose?
A business may differentiate so customers have a reason besides the lowest price, but customers must value the difference and there must be evidence they will pay. Adding cost to make a product seem special is not enough. A luxury position is one option, not a goal every business must pursue. B's higher price in the table does not make it a luxury product.
The creators' framework (“Red Ocean and Blue Ocean”) describes Red Ocean as competition for demand in an existing market. Quality, service, and cost can all be dimensions; it need not be a price war. By contrast, Blue Ocean aims to create uncontested market space and new demand by combining differentiation with low cost, or value innovation. It is not merely a luxury or niche market, and low cost does not necessarily mean the lowest selling price.
Returning to ROA, check net profit margin after the costs of differentiation, how added assets affect turnover, and what happens to cash, quality, and delivery capacity. A difference may be copied. Calling a strategy Blue Ocean does not guarantee profit or a return worth the risk.
In a hypothetical SI business, we might start by removing scope the customer does not use and testing a service package that solves a critical problem, rather than adding every feature. Before investing, ask the team: What will we remove? What will we add that customers will pay for? What extra cash and delivery capacity will it take? How will we prove it?
Separate current assets from long-term operating assets
For current assets, ask how collectible receivables are, whether allowances reflect risk, what old or damaged stock could sell for, and what conditions unbilled work must still meet. Higher volume may also require more receivables, inventory, or delivery capacity. The common THB 10 million average asset base in the table is a control assumption; test whether it can really stay unchanged.
For long-term assets such as machinery or delivery equipment, examine remaining useful life, condition, idle time, maintenance, and effects on scrap or delivery. A lower book value does not always prove better use. Software and SI teams should also track labor hours and rework. Labor is a resource to manage, but not automatically a balance-sheet asset.
Short and long horizons can call for different decisions
In the short term, allocate existing equipment and people to suitable work, reduce idle time, or resolve conditions delaying collection. Track quality and delivery obligations too. Deferring maintenance or rushing into rework may flatter a period's ratio while moving costs and risks into the next period. Check actual outcomes.
In the long term, equipment or systems investment can precede revenue. ROA may initially fall as assets rise before profit follows, while learning costs expensed now can also reduce profit. Track the capacity plan, returns, cash, and risks through the investment period. Short and long horizons are decision frames, not two ROA formulas. Before approving work or investment, ask which profit-per-sale or asset-use change is expected and what evidence will show quality remains adequate.
Break ROE into questions the team can investigate
Three-factor DuPont multiplies net profit/revenue, revenue/average assets, and average assets/average equity. Revenue and average assets cancel, leaving net profit/average equity, the defined ROE.
The first factor shows profit left from each baht of revenue. The second shows sales produced per baht of average assets. The last shows how large average assets are relative to average equity. Each points to different evidence.
The equity multiplier is not bank debt divided by equity. Assets are financed by several liabilities, including trade payables and customer advances. This formula uses averages, whereas Part 5's D/E used closing balances.
Calculate both years of the original company
Y2 has THB 12.4 million net profit, THB 125 million revenue, THB 72.5 million average assets, and THB 30 million average equity. Using matching bases produces the table below.
| Factor | Y1 | Y2 |
|---|---|---|
| Net profit ÷ revenue | 10.40% | 9.92% |
| Revenue ÷ average assets | 1.6807 times | 1.7241 times |
| Average assets ÷ average equity | 2.3333 times | 2.4167 times |
| First two factors multiplied = ROA | 17.48% | 17.10% |
| All three factors multiplied = ROE | 40.78% | 41.33% |
Y2 generates more sales per unit of assets by this formula, but not enough to offset the lower net profit margin, so ROA falls. A higher equity multiplier then makes the final ROE product exceed the prior year.
This observation does not establish the full business cause. Asset turnover can change with better use of delivery capacity, a new revenue mix, or investment timing. Open that evidence before calling the difference an efficiency gain.
DuPont factors and returns on two bases
Net profit margin, %
Chart scale: 0 to 15%
Net profit ÷ revenue
Total asset turnover, times
Chart scale: 0 to 2 times
Revenue ÷ average total assets
Equity multiplier, times
Chart scale: 0 to 3 times
Average total assets ÷ average equity
ROA using net profit, %
Chart scale: 0 to 20%
Net profit ÷ average total assets
ROE for common shareholders, %
Chart scale: 0 to 50%
Net profit ÷ average common equity
Equity changes for reasons besides profit
Y1 equity begins at THB 25 million, adds THB 10.4 million profit, and pays THB 9.4 million dividends, closing at THB 26 million. Y2 begins at THB 26 million, adds THB 12.4 million profit, and pays THB 4.4 million dividends, closing at THB 34 million.
Retained profit changes the equity base used in return ratios, so dividend policy is part of the story. A real company may also issue equity, repurchase shares, or record other comprehensive income; those would need reconciliation.
When comparing companies, do not assume the higher ROE operates better before checking equity. A small base due to accumulated losses or capital returns can inflate the ratio without stronger cash generation. If average equity is zero or negative, read the amounts rather than interpreting ROE in the usual way.
Use five-factor DuPont to separate tax and interest
Net profit margin can be split into net profit/profit before tax × profit before tax/EBIT × EBIT/revenue. Add asset turnover and the equity multiplier to get five-factor DuPont.
| Factor | Y1 | Y2 |
|---|---|---|
| Net profit ÷ profit before tax | 0.8000 | 0.8000 |
| Profit before tax ÷ EBIT | 0.8667 | 0.8611 |
| EBIT ÷ revenue | 0.1500 | 0.1440 |
| Revenue ÷ average assets | 1.6807 | 1.7241 |
| Average assets ÷ average equity | 2.3333 | 2.4167 |
| Product = ROE | 40.78% | 41.33% |
The assumed 20% tax rate stays constant, so it does not drive the year-to-year change. Profit before tax/EBIT falls slightly, as does EBIT/revenue. The breakdown points us to the profit and interest structure to examine.
The tax assumption is not a claim about any Thai company's rate. If profit before tax or EBIT is zero or negative, some factors are undefined or hard to interpret. Show the profit or loss and its causes directly rather than forcing every statement into five factors.
Compare similar business models before judging asset use
A hypothetical software company built on human skill and a factory requiring machinery have different asset bases even with similar revenue. Expensed spending versus amounts eligible for asset recognition can also change ratios. Check accounting policies and asset ages.
For project-based SI or Odoo Partner work, read actual hours, budgets, rework, and acceptance status alongside margin. If sales grow through labor-intensive jobs but actual hours are missing from cost records, interim profit may not yet reflect all delivery costs.
In production, inspect newly purchased machines, actual capacity use, scrap, and unsold inventory. Shrinking the asset base until delivery fails is not a good result, even if turnover looks higher for a while.
Use DuPont to name the next check
For this case, ask the team which costs drove net margin down and which jobs account for higher asset turnover in the formula. Finance should explain the changed equity base and dividend policy separately.
To use DuPont on your statements, first write all three factors from the same period. Ask each responsible owner for one set of evidence explaining the change. Gaps in that explanation show what the next report must add.
Source framework and scope of the example
This article uses DuPont and the stated return definitions. The figures are original hypothetical examples calculated consistently from opening-and-closing averages. Do not compare them with reports using different profit or denominator definitions without reconciling those first. For more on DuPont, see CFA Institute: Financial Analysis Techniques
