Profitability Indicator Ratios: Return On Capital Employed
  1. Profitability Indicator Ratios: Introduction
  2. Profitability Indicator Ratios: Profit Margin Analysis
  3. Profitability Indicator Ratios: Effective Tax Rate
  4. Profitability Indicator Ratios: Return On Assets
  5. Profitability Indicator Ratios: Return On Equity
  6. Profitability Indicator Ratios: Return On Capital Employed

Profitability Indicator Ratios: Return On Capital Employed

By Richard Loth (Contact | Biography)

The return on capital employed (ROCE) ratio, expressed as a percentage, complements the return on equity (ROE) ratio by adding a company's debt liabilities, or funded debt, to equity to reflect a company's total "capital employed". This measure narrows the focus to gain a better understanding of a company's ability to generate returns from its available capital base.

By comparing net income to the sum of a company's debt and equity capital, investors can get a clear picture of how the use of leverage impacts a company's profitability. Financial analysts consider the ROCE measurement to be a more comprehensive profitability indicator because it gauges management's ability to generate earnings from a company's total pool of capital.

Formula:


Components:


As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings had net income of $732.50 (income statement). The company's average short-term and long-term borrowings were $366.60 and the average shareholders' equity was $4,312.70 (all the necessary figures are in the 2004 and 2005 balance sheets), the sum of which, $4,679.30 is the capital employed. By dividing, the equation gives us an ROCE of 15.6% for FY 2005.

Variations:
Often, financial analysts will use operating income (earnings before interest and taxes or EBIT) as the numerator. There are various takes on what should constitute the debt element in the ROCE equation, which can be quite confusing. Our suggestion is to stick with debt liabilities that represent interest-bearing, documented credit obligations (short-term borrowings, current portion of long-term debt, and long-term debt) as the debt capital in the formula.

Commentary:
The return on capital employed is an important measure of a company's profitability. Many investment analysts think that factoring debt into a company's total capital provides a more comprehensive evaluation of how well management is using the debt and equity it has at its disposal. Investors would be well served by focusing on ROCE as a key, if not the key, factor to gauge a company's profitability. An ROCE ratio, as a very general rule of thumb, should be at or above a company's average borrowing rate.

Unfortunately, there are a number of similar ratios to ROCE, as defined herein, that are similar in nature but calculated differently, resulting in dissimilar results. First, the acronym ROCE is sometimes used to identify return on common equity, which can be confusing because that relationship is best known as the return on equity or ROE. Second, the concept behind the terms return on invested capital (ROIC) and return on investment (ROI) portends to represent "invested capital" as the source for supporting a company's assets. However, there is no consistency to what components are included in the formula for invested capital, and it is a measurement that is not commonly used in investment research reporting.

Proceed to the next chapter on Debt Ratios here.
Or, click here to return to the Financial Ratio Tutorial main menu.


  1. Profitability Indicator Ratios: Introduction
  2. Profitability Indicator Ratios: Profit Margin Analysis
  3. Profitability Indicator Ratios: Effective Tax Rate
  4. Profitability Indicator Ratios: Return On Assets
  5. Profitability Indicator Ratios: Return On Equity
  6. Profitability Indicator Ratios: Return On Capital Employed
RELATED TERMS
  1. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  2. Adjusted EBITDA

    Adjusted EBITDA is a measure computed for a company that looks ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure ...
  4. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are ...
  5. Green Fund

    A mutual fund or other investment vehicle that will only invest ...
  6. IRR Rule

    A measure for evaluating whether to proceed with a project or ...
RELATED FAQS
  1. What is the formula for calculating EBITDA?

    Learn about EBITDA and how companies can manipulate this calculation to look more profitable. Read Answer >>
  2. What are some of the common trends of the Average Revenue Per User in the telecommunications ...

    Learn about the common trends in the average revenue per user, or APRU, for the telecommunications industry and why ARPU ... Read Answer >>
  3. What information should I look at on a publicly traded company for use in fundamental ...

    Learn what information is important in fundamental analysis of a publicly traded company and how to use it to assess the ... Read Answer >>
  4. Why is it important for an investor to understand business accounting?

    Learn to understand why it is important for an investor to understand business accounting to perform investment and credit ... Read Answer >>
  5. How is an accrued interest entry made in accounting?

    Learn how to create common journal entries for accrued interest, including adjusting entries and delayed bond issues sold ... Read Answer >>
  6. Is return on sales (ROS) the same as profit margin?

    Take an in-depth look at the similarities and possible differences between return on sales, or ROS, and profit margin, two ... Read Answer >>

You May Also Like

Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center