To calculate the Return on Capital Employed (ROCE), you’ll need two pieces of information: the operating profit and the capital employed.
Page written by Ian Hawkins. Last reviewed on July 15, 2024. Next review due April 1, 2025.
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Return on capital employed (ROCE) is a key financial ratio used to measure a company’s profitability and the efficiency with which its capital is employed. ROCE helps investors and analysts understand how well a company is generating profits from its capital over a longer period. It’s particularly useful in gauging the long-term performance or profitability of a company.
A higher ROCE generally suggests a more efficient company. However, it can also indicate a company with a significant amount of cash on hand, as cash is included in total assets. This means high levels of cash can sometimes skew this metric.
The formula for ROCE is:
ROCE=EBIT/Capital Employed
Where capital employed can be calculated as:
Capital Employed=Total assets−Current liabilities
Let’s say a Canadian company has an EBIT of CAD 500,000. Its total assets are CAD 2,000,000, and its current liabilities are CAD 500,000. The capital employed is: Capital Employed=CAD2,000,000−CAD500,000=CAD1,500,000
So, the ROCE is:
ROCE=CAD500,000/CAD1,500,000≈0.33 or 33%
This means for every dollar of capital employed, the company generates 33 cents in profit.
ROCE is important because it provides insight into how efficiently a company is using its capital to generate profits. It’s a useful measure for investors who want to compare the profitability of companies within the same industry or track a company’s performance over time. A consistent or improving ROCE indicates good financial health and efficient use of capital, making it an attractive metric for investors.
ROCE stands for Return on Capital Employed. It is a financial ratio that measures the profitability and efficiency of a company’s capital investments. ROCE indicates how well a company is generating profits from its invested capital.
ROCE is used as a performance metric by investors, analysts, and managers to assess a company’s profitability and the efficiency with which it utilizes its capital. A higher ROCE indicates that the company is generating more profits relative to the capital invested, which is generally considered favorable.
It’s important to note that ROCE can vary across industries, so it is often more meaningful to compare a company’s ROCE to its industry peers to get a better understanding of its performance.
Generally, a higher ROCE value is better. A good rule of thumb is to aim for a ROCE of at least 15% to 20%. However, this benchmark can vary by industry. For example, in the manufacturing sector, ROCE can exceed 25%, while in retail, it typically ranges from 5% to 15%.
A business should aim to generate a ROCE that consistently exceeds its weighted average cost of capital (WACC). This means the company is making a higher return on the money spent funding the business than the average cost of that funding (from both debt and equity).
A higher ROCE indicates a company is in a strong financial position and is generating significant profit. To assess whether your company has a good ROCE, compare it to other companies in the same industry. The company with the highest ROCE is generally the most profitable.
You can also compare ROCE to returns from previous years. If the ratios are trending downward, it indicates declining profitability. Conversely, an increasing ROCE suggests improving profitability.
To improve ROCE, companies can:
ROCE has limitations, such as:
A good net profit margin varies by industry but typically ranges from 5% to 20%. Companies in highly competitive industries might have lower margins, while those with strong market positions might have higher margins.
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