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Definition
Return on capital employed (ROCE) is a financial metric used to evaluate the profitability and efficiency of a company’s capital investments.
What is return on capital employed?
Return on capital employed measures how effectively a company is generating profits from its capital investments, including both debt and equity.
The formula for ROCE is as follows:
ROCE = (EBIT / Capital employed) x 100
ROCE is a key measure for investors, analysts, and management because it provides insights into how efficiently a company is using its capital to generate profits. A higher ROCE indicates that the company is generating more profits per unit of capital employed, which is generally favourable. Conversely, a lower ROCE suggests inefficiency in capital allocation.
This metric takes into account the capital structure of the company, including both debt and equity. It provides insights into how effectively the company is managing its debt obligations while generating profits.
While ROCE is a valuable metric, it has limitations. For example, it may be influenced by accounting practices, industry norms, and economic cycles. Additionally, it does not consider the cost of capital explicitly, which can vary based on market conditions.
If you want to calculate the return on capital employed for your business, try our handy calculator today.
Example of return on capital employed
Let’s consider a company, ABC Inc., which reported an earnings before interest and taxes (EBIT) of ₦500,000 for the year. The company’s total capital employed, including both debt and equity, is ₦2,000,000.
Using the formula for ROCE:
ROCE = (500,000 / 2,000,000) x 100 = 25%
This means that ABC Inc. generated a return of 25% on its capital employed during the specified period. In other words, for every naira of capital invested in the business, ABC Inc. earned 25 kobo in operating profit.
