What Is Cash Return on Capital Invested – CROCI?
Cash return on capital invested (CROCI) is a method of valuation that compares a company's cash return to its equity. Developed by the Deutsche Bank's global valuation group, CROCI provides analysts with a cash-flow-based metric for evaluating the earnings of a company. Also known as "cash return on cash invested."
Cash return on capital invested is a variation of the economic profit model. In essence, CROCI measures the cash profits of a company as a proportion of the funding required to generate them. It acknowledges both common and preferred share equity (as well as long-term funded debt) as sources of capital.
The Formula for CROCI Is
CROCI=Total Equity ValueEBITDAwhere:EBITDA=Earnings before interest, taxes, depreciation, and amortization
What Does Cash Return on Capital Invested Tell You?
The valuation represented by cash return on capital invested strips out the effect of non-cash expenses, allowing investors to focus their attention on the company’s cash flow. It also can eliminate certain subjective representations of earnings that might be found in other types of metrics that can be influenced by the accounting practices adopted by a company.
CROCI may be used as a gauge of the effectiveness and efficiency of a company’s management, as it makes clear the results of the capital investment strategy being employed. The results of this formula can be used a variety of ways. While a higher ratio of cash returned is naturally desirable, putting the formula to work over several financial periods can form an even clearer picture.
For instance, a company might have CROCI that shows it is well-managed at the moment, but determining how it is operating may require measuring these values to show either growth or decline.
A company that maintains a positive valuation as represented by this metric may still exhibit declines that can indicate a loss of efficiency or other questionable strategic choices. For example, companies regularly invest in the creation of new products, marketing campaigns, or development strategies.
The results of those investments will be made evident through this formula as it narrows attention to the cash flow that results rather than getting drawn into accounting methods that may obscure or diminish the downside to those plans. If a retailer, for instance, has put capital toward opening new stores, yet the resulting sales revenue does not increase in kind, this formula could be used to show the inefficiencies in that strategy.
Likewise, a retailer might see a stronger CROCI by adopting a different approach that either yields higher sales revenue or calls for a smaller capital investment.
The Difference Between CROCI and ROIC
Return on invested capital (ROIC) is also employed as a calculation used to assess a company's efficiency at allocating the capital under its control to generate profitable investments. Calculating return on invested capital assesses the value of total capital, which is the sum of a company's debt and equity. Meanwhile, CROCI is only concerned with cash flows relative to equity.