Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE) is a key financial ratio that measures how efficiently a company is using its capital to generate profit. It indicates the return a company earns on the total capital it has invested in its business. A higher ROCE generally suggests better profitability and efficiency.

Formula

The formula for calculating ROCE is:

ROCE = $\frac{EBIT}{Capital Employed}$

Where:

• EBIT stands for Earnings Before Interest and Tax. This represents the profit a company makes before deducting interest expenses and income tax.
• Capital Employed represents the total amount of capital invested in the business to generate profits. It is typically calculated as Total Assets minus Current Liabilities.

Calculating Capital Employed

Capital Employed can be calculated in a few ways:

• Total Assets - Current Liabilities: This is the most common method.
• Shareholders' Equity + Total Debt: This method focuses on the sources of funding for the business.

Understanding ROCE

A high ROCE indicates that a company is effectively using its capital to generate profits. Conversely, a low ROCE suggests that the company is not utilizing its capital efficiently.

ROCE is often compared to a company's cost of capital. If the ROCE is greater than the cost of capital, it indicates that the company is creating value for its shareholders.

Example Calculation

Let's consider a company with the following financial data:

• EBIT = $500,000
• Total Assets = $2,000,000
• Current Liabilities = $500,000

First, calculate Capital Employed:

Capital Employed = Total Assets - Current Liabilities = $2,000,000 - $500,000 = $1,500,000

Now, calculate ROCE:

ROCE = $\frac{EBIT}{Capital Employed} = \frac{$500,000}{$1,500,000} = 0.3333$ or 33.33%

This means that for every $1 of capital employed, the company generates $0.33 in profit.

Table Summary

Ratio	Formula	Interpretation
Return on Capital Employed (ROCE)	$\frac{EBIT}{Capital Employed}$	Measures the profitability of a company in relation to the capital invested. A higher ROCE is generally better.