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.

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  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. Return On Capital Employed (ROCE)

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  2. Return on Average Capital Employed - ROACE

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  3. Capital Employed

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  4. Debt Ratio

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  5. Return On Equity - ROE

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RELATED FAQS
  1. What are some ways a company can improve on its Return on Capital Employed (ROCE)?

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  2. What is the difference between ROCE and ROA?

    Understand the difference between the profitability ratios of return on capital employed and return on assets, and learn ... Read Answer >>
  3. What is the difference between ROCE and ROE?

    Discover how investors and analysts utilize the return on equity and return on capital employed ratios to gauge financial ... Read Answer >>
  4. What does a high capital employed imply about risk?

    Learn what capital employed indicates about a company's operational risk level, and how the return on capital employed can ... Read Answer >>
  5. What is the difference between ROCE and ROI?

    Understand the difference between return on capital employed and return on investment and how analysts use these performance ... Read Answer >>
  6. What is the difference between ROCE and ROOC?

    Find out about the differences between return on capital employed and return on operating capital, two accounting ratios ... Read Answer >>
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