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Return on Capital Employed

 

Return on capital employed ratio (ROCE) measures company’s return compared to its employed capital. Return in this case is some kind of profit (mostly EBIT or NOPAT) and the capital employed means equity capital and debt capital.  

 

Basically, this ratio indicates the profitability of company’s assets (adjusted). Higher ROCE ratio means higher value of the company, because shareholders can get higher return on their capital. However, return on capital employed is based on historical return and book value of capital. Both these assumptions make this ratio not very reliable in practice. This ratio is really valuable in practice only if high historical return on capital employed can be maintained on new investments of the company. 

 

If return on capital is very low, it indicates that an organic expansion is very questionable and investors should not expect some rapid growth of such company. In some rear cases, ROCE can be low if book value of assets is much higher than market value

 

Formula 

 

Most known formula: 

 

(1) ROCE = EBIT / Total assets – Current liabilities

 

Other ROCE formulas used in practice: 

 

(2) ROCE = NOPAT / (Shareholders’ equity + Financial liabilities)

 

The formula above (2) is the most accurate.

 

(3) ROCE = Operating income / (Shareholders’ equity + Non-current liabilities)

 

* There can be even more variations of ROCE formula, while some use net income in nominator, but it is not very accurate. Also it is popular to use annual average of capital employed (denominator from the formula) which is in most cases more accurate than just use the capital employed at the end of the period from balance sheet

 

If calculated correctly, ‘return on capital employed’ is the same as ‘return on invested capital’ (ROIC) which only sounds differently but has the same meaning. Yet, these ratios might be calculated differently, because there are many modifications how to calculate ROCE and ROIC. 

 

 






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