In the year 1918, the well known electrical engineer F. Donaldson Brown of E.I Du Pont Corporation of Wilmington Delaware was given the responsibility of solving the financial issues of the company. Brown identified a mathematical relationship between the two popular ratios namely, the net profit margin ratio, the total asset turnover ratio and the ROA. The result of the ROA comes from the net profit margin ratio and the total asset turnover.
The Du Pont Analysis is a performance measurement that can be calculated with the gross book value instead of the net book value for producing the higher rate of interest (ROE). Sometimes, it may also known as the ‘Du Pont Identity’ The Du Pont analysis clarifies that ROE is generally affected by three important factors:
- The efficiency of the assets used , which can be measured by the total asset turnover
- The financial leverage that can be calculated by the equity multiplier
- The operating efficiency which can be considered through the profit margin
Therefore ROE = Profit Margin * Total Asset Turnover * Equity multiplier
Where the profit margin = profit /sales, total asset turnover = sales / assets, equity multiplier = assets/equity