Return on Capital Employed (ROCE)

Definition

Return on Capital Employed (ROCE) is a financial ratio that measures a company’s profitability and the efficiency with which its capital is used. In other words, the ratio tells us the profit a company generates from every dollar it has invested in its business. It is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its total capital employed.

Phonetic

The phonetic pronunciation of “Return on Capital Employed (ROCE)” is:riːˈtərn ɒn ˈkæpɪtl ɪmˈplɔɪd (ɑːr oʊ siː iː)

Key Takeaways

<ol><li>ROCE is a financial metric that measures a company’s profitability and the efficiency with which its capital is employed. It is calculated by dividing EBIT (Earnings Before Interest and Tax) by the total capital employed (Debt + Equity). A high ROCE can indicate that a company is investing its capital efficiently, while a low ROCE could suggest the opposite.</li><li>ROCE is an important tool in comparing the relative profitability of companies. If two businesses have the same net profit, the company with a lower amount of total capital would have a higher ROCE, indicating it’s more proficient at converting its capital into profits.</li><li>Like all financial metrics, ROCE should be used in combination with other indicators for accurate analysis. It does not account for the future capital expenditures which could affect a company’s profitability. Therefore, while it provides useful insights about the current efficiency of employing capital, it cannot predict the company’s future performance.</li></ol>

Importance

Return on Capital Employed (ROCE) is an important financial metric as it measures efficiency and profitability, by showing how effectively a company is using its capital. ROCE allows a company to assess its performance over time and in comparison to competitors within the same industry. By quantitatively assessing the returns generated from the total capital employed (both equity and debt), it provides valuable information about the financial health and sustainability of the business. A higher ROCE suggests more efficient capital deployment, translating into higher profitability and better growth prospects, while a lower ROCE might indicate inefficiencies and potential issues regarding the company’s long-term viability. Hence, ROCE is a crucial indicator for investors and stakeholders.

Explanation

The primary purpose of Return on Capital Employed (ROCE) is to ascertain a company’s efficiency and profitability with respect to the capital employed in its operations. It serves as a critical measuring tool for investors and analysts as it provides insight into how well a company can generate profits from its capital employed. This metric is especially significant for companies with substantial investments in capital assets. By comparing ROCE with a company’s debt levels, investors can get a clear picture of how well the operations are funded and how those operations fund other areas of the business.ROCE is also widely used for inter-firm comparison and determining a company’s financial performance over time. It affords a comprehensive snapshot of the history of a business’s earnings and investment performance. A higher ROCE indicates a more efficient use of capital in creating profits and thus, a more favorable investment. In other words, investors and analysts look for companies with ROCEs that are higher than their cost of capital. Thus, ROCE is used by businesses and investors to measure the health of a company and to compare the profitability and efficiency of different companies.

Examples

1. Apple, Inc.: For the fiscal year 2019, Apple had a ROCE of over 20%, which indicates that the company generated 20 cents of profit for every dollar it invested in its capital (equipment, properties, etc.). This high ROCE suggests effective usage of capital and a successful business model that converts investments into profitability.2. Walmart: As of 2021, Walmart had a ROCE of around 8%, demonstrating how revenue is being generated from its capital employed. This figure suggests that Walmart uses its capital relatively well, generating 8 cents of profits for every dollar invested in the business. 3. Amazon.com, Inc.: Amazon had a relatively high ROCE at 11.88% for the fiscal year 2020. This shows the company is proficient at using its total capital to generate profits, essentially producing nearly 12 cents of profit for each dollar of capital employed in the business. This is a strong indication of Amazon’s efficiency and profit-generating ability.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Capital Employed: This refers to the amount of money invested in a business, including equity and long-term liabilities. It is the value of the resources that a company has utilized to generate profits.
• Net Operating Profit: This is the profit a company makes after deducting operating expenses such as wages, depreciation, and cost of goods sold, but before interest and taxes. It’s also known as EBIT (Earnings Before Interest and Taxes).
• Efficiency Ratio: This is a measure of a company’s ability to utilize its capital and resources efficiently to generate profits. It’s often used in ROCE calculations.
• Investment Appraisal: This is the process of evaluating the viability or profitability of an investment proposal. ROCE is often used in investment appraisal to determine the returns on investments.
• Economic Profit: Unlike accounting profit, economic profit takes into account the opportunity cost of capital employed. If ROCE is lower than the opportunity cost of capital, it indicates that the company is not generating economic profit.

Sources for More Information

• Investopedia
• Corporate Finance Institute
• AccountingTools
• ReadyRatios