Return on Average Capital Employed - ROACE

What is 'Return on Average Capital Employed - ROACE'

The return on average capital employed (ROACE) is a financial ratio that shows profitability versus the investments a company has made in itself. This metric differs from the return on capital employed (ROCE) calculation, in that it takes the average of the opening and closing capital for a period of time, as opposed to only the capital figure at the end of the period.

BREAKING DOWN 'Return on Average Capital Employed - ROACE'

Return on average capital employed is a useful ratio when analyzing businesses in capital-intensive industries, such as oil. Businesses that are able to squeeze higher profits from a smaller amount of capital assets will have a higher ROACE than businesses that are not as efficient in converting capital into profit. The formula for the metric is:

ROACE = Earnings before interest and taxes (EBIT) / (Average Total Assets - Average Current Liabilities)

This is different than ROCE in that:

ROCE = EBIT / Capital Employed, where Total Assets - Current Liabilities = Capital Employed

Investors should be careful when using the ratio, since capital assets, such as a refinery, can be depreciated over time. If the same amount of profit is made from an asset each period, the asset depreciating will make ROACE increase because it is less valuable. This makes it look as if the company is making good use of capital, though it is really not making any additional investments.

Return on Average Capital Employed Example Calculation

As an example of how to calculate ROACE, assume that a company begins the year with $500,000 is assets and $200,000 in liabilities. It ends the year with $550,000 in assets and the same $200,000 in liabilities. During the course of the year, the company earned $150,000 of revenue and had $90,000 of total operating expenses. Step one is to calculate the EBIT.

EBIT = Revenue - operating expenses = $150,000 - $90,000 = $60,000

The second step is to calculate the average capital employed. This is equal to the average of the total assets minus the liabilities at the beginning of the year and the end of the year.

Capital employed at the beginning of the year = $500,000 - $200,000 = $300,000

Capital employed at the end of the year = $550,000 - $200,000 = $350,000

Average capital employed = ($300,000 + $350,000) / 2 = $325,000

Lastly, by dividing the EBIT by the average capital employed, the ROACE is determined:

ROACE = $60,000 / $325,000 = 18.46%