A:

Options available to a company seeking to improve on its return on capital employed (ROCE) ratio include reducing costs, increasing sales, and paying off debt or restructuring financing. ROCE is a metric that measures the profitability of a company. It helps analysts assess how efficiently a company employs its available capital.

The ROCE ratio is particularly helpful when comparing profitability across companies in the same business with similar amounts of working capital. This metric is also very useful for companies that require large amounts of capital to facilitate production, otherwise known as capital-intensive industries. ROCE accounts for debt and additional liabilities, unlike other profitability ratios, such as the return on equity (ROE) ratio. Analysts and investors use the ROCE ratio in conjunction with the ROE ratio to get a more well-rounded idea of how well a company can generate profit from the capital it has available.

The formula used to calculate ROCE divides a company’s earnings before interest and taxes (EBIT) with capital used. If a company’s ROCE ratio is relatively high, that is commonly interpreted as an indication that the company is making more efficient use of its capital.
Because it is a measurement of profitability, a company can improve its ROCE through the same processes that it undertakes to improve its overall profitability. The most obvious place to start is by reducing costs or increasing sales. Monitoring areas that may be racking up excessive or inefficient costs is an important part of operational efficiency.

Another action that can improve the ROCE ratio is selling off of unprofitable or unnecessary assets. For example, a company would do well to sell a piece of machinery that has outlived its useful life. Selling the outdated machinery would lower the company’s total asset base and thus improve the company’s ROCE, since removing unused or unnecessary assets allows for less capital to be employed to facilitate the same amount of production.

Paying off debt, thereby reducing liabilities, can also improve the ROCE ratio. Another step a company can take in the area of financing is to restructure existing debt, refinancing at lower interest rates or with more attractive payment terms.

A key area to overall operational inefficiency that may be improved upon is inventory management. Proper inventory management can often be a very effective means of improving a company's overall financial performance. Proper monitoring, organization and coordination of ordering inventory can significantly improve a company's cash flow and available working capital. This allows the company to reinvest more capital back into the company on a regular basis, which enables it to grow and increase its market base.

RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. Is it important for a company always to have a high liquidity ratio?

    Understand the significance of the liquidity ratio and how it is used in conjunction with other measures to arrive at an ... Read Answer >>
  4. How can I calculate capital employed from a company's balance sheet?

    The simplest presentation of capital employed is total assets minus current liabilities. Sometimes, it is equal to all current ... Read Answer >>
Related Articles
  1. Investing

    Spotting Profitability With ROCE

    This straightforward ratio measures whether a company is efficient, money-making or neither.
  2. Investing

    Key Financial Ratios to Analyze Investment Banks

    Find out which financial ratios are most useful when analyzing an investment bank, and why tracking capital efficiency is especially important.
  3. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  4. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  5. Investing

    Key Financial Ratios for Pharmaceutical Companies

    Because of the unique requirements for bringing products to market, pharmaceutical industry stocks are best analyzed by using certain key financial ratios.
  6. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  7. Investing

    The Optimal Use Of Financial Leverage In A Corporate Capital Structure

    The amount of debt and equity that makes up a company's capital structure has many risk and return implications.
  8. Investing

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  9. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
RELATED TERMS
  1. Return On Capital Employed (ROCE)

    Return on Capital Employed (ROCE) is a financial ratio that measures ...
  2. Return on Average Capital Employed - ROACE

    A financial ratio that shows profitability compared to investments ...
  3. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  5. Days Working Capital

    An accounting and finance term used to describe how many days ...
  6. Operating Ratio

    A ratio that shows the efficiency of a company's management by ...
Hot Definitions
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  2. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  3. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  4. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  5. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  6. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
Trading Center