developed the DuPont return on investment relationship to access the
firm’s financial performance. General Electric calculated profitability by
dividing earnings by sales (or costs). However, this calculation ignored
the magnitude of invested capital. In 1903, Pierre DuPont created a new
general ledger account for “permanent investment,” where capital expen-
ditures were charged at cost. The DuPont Corporation executive commit-
tee was presented with monthly sales, income, and return on invested
capital on the firm’s 13 products in 1904 (Chandler 1977). Donald
Brown contributed to the DuPont analysis by pointing out that as sales
volume rose, the return of invested capital rose, even if prices remained
constant. Brown’s turnover analysis was defined as sales divided by total
investment. The multiplication of turnover by the ratio of earnings to
sales produced the DuPont return on invested capital, still in use by the
DuPont Corporation and most American firms. Total investment includes
working capital, cash, inventories, and accounts receivable, as well as
permanent investment, bonds, preferred stock, and stocks. The DuPont
return on invested capital combines and consolidates financial, capital,
and cost accounting. The DuPont return on total investment helped
DuPont develop many modern management procedures for creating op-
erating and capital budgeting and making short-run and long-run finan-
cial forecasts.
A second composite model is the Altman Z model, which is useful to
identify potentially bankrupt firms. The Altman Z score used five primary
ratios in its initial 1968 version.
Z = .012X 1 + .014X 2 + .033X 3 + .006X 4 + .999X 5whereX 1 = (Current assets – Current liabilities)/Total assets
X 2 = Retained earnings/Total assets
X 3 = EBIT/Total assets
X 4 = Market value of equity/Book value of debt
X 5 = Sales/Total assets
The Altman Z score used a liquidity, past profitability, (present) prof-
itability, leverage, and sales turnover ratios to produce a single score. An
Altman Z score of less than 2.67 implied that the firm was not healthy. An
Altman Z score exceeding 2.67 implied financial health. The Altman Z
score successfully predicted impending bankruptcy for 32 of 33 firms (97
percent) in the year prior to bankruptcy, for Altman’s initial sample. The
model correctly predicted 31 of 33 (94 percent) nonbankrupt firms in this
sample for the year prior to bankruptcy.