Return on Capital Employed (ROCE) vs. Return on Assets (ROA): An Overview
Return on capital employed (ROCE) and return on assets (ROA) are two similar profitability ratios investors and analysts use to evaluate companies. The ROCE ratio is a metric that evaluates how efficiently a company’s available capital is utilized.
- Return on capital employed (ROCE) and return on assets (ROA) are profitability ratios.
- ROCE is similar to return on equity (ROE), except it includes debt liabilities, where a higher ratio means a company is making good use of its available capital.
- ROCE is best used to compare companies in capital-intensive sectors—i.e. those companies that carry a lot of debt.
- Return on assets (ROA), unlike ROCE, focuses on the efficient use of assets.
- These profitability ratios are best used to compare similar companies in the same industry.
Return on Capital Employed (ROCE)
The formula to calculate ROCE is as follows:
Capital employed is defined as total assets minus current liabilities or total shareholders' equity plus debt liabilities. Therefore, it is similar to the return on equity (ROE) ratio, except it also includes debt liabilities.
The higher the ROCE, the more efficiently a company makes use of its available capital to generate profits. The ROCE ratio is especially useful for comparing similar capital-intensive companies. A good ROCE ratio for a company should always be higher than its average financing interest rate.
ROCE is best used when comparing companies in capital-intensive sectors, such as utilities and telecoms, because unlike other fundamentals, ROCE considers debt and other liabilities as well. The ROCE is useful for comparing companies with significant debt.
ROCE may need adjustments, including subtracting cash from capital employed to get a more accurate measure of ROCE. The long-term ROCE is important, where investors favor companies with stable and rising ROCE numbers.
Return on Assets (ROA)
The ROA ratio divides annual earnings by total assets to indicate how much revenue per dollar is generated in relation to the company's assets. It is calculated using the following equation:
ROA=Total AssetsNet Income
A high value of the ROA ratio is a strong indication a company is functioning well, making significant returns from assets. As with other profitability ratios, the ROA is best used to compare similar companies in the same industry.
The differences between the ROCE and ROA ratios are not many, but they are significant. Different profitability ratios exist precisely to enable investors and analysts to evaluate a company's operational efficiency from various perspectives to obtain a fuller picture of a company's true value, financial condition, and growth prospects.