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. ROCE is calculated in the following manner:
Return on capital employed=Capital usedEBITwhere:EBIT=Earnings before interest and taxes
How ROCE Is Used
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 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 Selling the outdated machinery would lower the company’s total asset base and thus improve the company’s ROCE since removing unused or unnecessary assets allows for less capital to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 repayment 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.