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RETURN ON CAPITAL EMPLOYED

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Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is realizing from its capital employed. The ratio can also be seen as representing the efficiency with which capital is being utilized to generate revenue. It is commonly used as a measure for comparing the performance between companies and for assessing whether a company generates enough returns to pay for its cost of capital.

Contents

The formula

ROCE\ =\ \frac{Pretax\ operating\ profit}{Capital\ employed}\ =\ \frac{EBIT}{Total\ assets - Current\ liabilities}

The Formula

Return on net assets (%) = (Operating Profit / Net assets) * 100

Return on net assets is also sometimes known as return on capital employed.

The Meaning of ROCE

Return on Capital Employed ratio measures the efficiency of the business in using the capital invested in it to make a profit. Therefore, the higher the percentage the more efficient the company is.

Factors increasing the ROCE

Increases to the ROCE are generally caused by one of the following factors.

  • Prices have increased faster than costs.
  • The cost of the relevant goods or materials has decreased.

Additional and alternative definitions

A different way to calculate ROCE is ROACE, Return on AVERAGE Capital Employed. Instead of using the capital as reported, it uses the average of opening and closing capital for the time period.

How it works

It simply shows how much profit a business is making on the capital invested in it and through that, how efficient a business is in utilising its Net Assets to generate revenue and therfore, profits.

References

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