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The DuPont Equation (ROE)

ZACH DE GREGORIO, CPA www.WolvesAndFinance.com The DuPont Equation is one of the most important innovations in business. Before we get to the equation, I need to tall you the story of how the equation came about. Most of you know DuPont is a chemical company, and has been one of the biggest companies in the world for a long time. This equation was invented by somebody named Donaldson Brown. Donaldson is one of my personal heroes and he had an amazing career. Donaldson Brown did accounting and corporate finance at DuPont. He got an engineering degree in college and started working in the explosives department at DuPont in 1908. He was so successful, he became the manager of the whole department. He left this position to work in the Treasurer’s office managing the company’s money. It was his time in the treasurer’s office where he developed what is known as the DuPont equation. DuPont is the first place I can find in history records where they created a business laboratory. There was a secret room at DuPont called “the chart room.” The leadership of DuPont would come into this room, and Donaldson would show them financial charts, they would apply the DuPont equation, and they would make financial choices. Meanwhile, DuPont made a large investment in General Motors, and Donaldson become the VP of Finance at General Motors. Eventually he became vice chairman of the board of General Motors. This guy had an incredible career, starting out as an explosives engineer and ending up on the board of General Motors. You have to understand, during the time Donaldson worked in corporate finance at General Motors, it became the largest corporation in the world. Donaldson started with the accounting ratio Return on Equity. This is Net Income / Owner’s Equity. This ratio decribes that the owner’s put a certain amount of investment into a business which generates a certain amount of profit each year. This is useful information. However, it would be helpful to be able to drill down and understand what is driving Return on Equity. That is what the DuPont Equation achieves. The DuPont Equation says that Return on Equity = Profit Margin * Asset Turnover * Financial Leverage. This works because when you multiply these three ratios, sales and assets cancel each other out and you are left with Net Income over Owner’s Equity, or Return on Equity. Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.