Return on Capital Employed (ROCE): Ratio, Interpretation, and Example

What Is Return on Capital Employed (ROCE)?

The term return on capital employed (ROCE) refers to a financial ratio that can be used to assess a company's profitability and capital efficiency. In other words, this ratio can help to understand how well a company is generating profits from its capital as it is put to use. ROCE is one of several profitability ratios financial managers, stakeholders, and potential investors may use when analyzing a company for investment.

Understanding Return on Capital Employed (ROCE)

Return on capital employed can be especially useful when comparing the performance of companies in capital-intensive sectors, such as utilities and telecoms. This is because, unlike other fundamentals such as return on equity (ROE), which only analyzes profitability related to a company’s shareholders’ equity, ROCE considers debt and equity. This can help neutralize financial performance analysis for companies with significant debt.

Ultimately, the calculation of ROCE tells you the amount of profit a company is generating per $1 of capital employed. The more profit per $1 a company can generate, the better. Thus, a higher ROCE indicates stronger profitability across company comparisons.

For a company, the ROCE trend over the years can also be an important indicator of performance. Investors tend to favor companies with stable and rising ROCE levels over companies where ROCE is volatile or trending lower.

ROCE is one of several profitability ratios that can be used when analyzing a company’s financial statements for profitability performance. Other ratios can include the following:

• ROE
• Return on assets (ROA)
• Return on invested capital (ROIC)

How to Calculate ROCE

The formula for ROCE is as follows:

$\begin{aligned} &\text{ROCE} = \frac{ \text{EBIT} }{ \text{Capital Employed} } \\ &\textbf{where:}\\ &\text{EBIT} = \text{Earnings before interest and tax} \\ &\text{Capital Employed} = \text{Total assets } - \text{ Current liabilities} \\ \end{aligned}$​ROCE=Capital EmployedEBIT​where:EBIT=Earnings before interest and taxCapital Employed=Total assets − Current liabilities​

ROCE is a metric for analyzing profitability and for comparing profitability levels across companies in terms of capital. Two components are required to calculate ROCE. These are earnings before interest and tax (EBIT) and capital employed.

Also known as operating income, EBIT shows how much a company earns from its operations alone without interest on debt or taxes. It is calculated by subtracting the cost of goods sold (COGS) and operating expenses from revenues.

Capital employed is very similar to invested capital, which is used in the ROIC calculation. Capital employed is found by subtracting current liabilities from total assets, which ultimately gives you shareholders’ equity plus long-term debts. Instead of using capital employed at an arbitrary point in time, some analysts and investors may choose to calculate ROCE based on the average capital employed, which takes the average of opening and closing capital employed for the time period under analysis.

Return on Capital Employed (ROCE) vs. Return on Invested Capital (ROIC)

When analyzing profitability efficiency in terms of capital, both ROIC and ROCE can be used. Both metrics are similar in that they provide a measure of profitability per total capital of the firm. In general, both the ROIC and ROCE should be higher than a company’s weighted average cost of capital (WACC) in order for the company to be profitable in the long term.

ROIC is generally based on the same concept as ROCE, but its components are slightly different. The calculation for ROIC is as follows:

Net Operating Profit After Tax ÷ Invested Capital

Net operating profit after tax is a measure of EBIT x (1 – tax rate). This takes into consideration a company’s tax obligations, but ROCE usually does not.

Invested capital in the ROIC calculation is slightly more complex than the simple calculation for capital employed used in ROCE. Invested capital may be either:

Net Working Capital + Property Plant and Equipment (PP&E) + Goodwill and Intangibles

or

Total Debt and Leases + Total Equity and Equity Equivalents + Non-Operating Cash and Investments

The invested capital is generally a more detailed analysis of a firm’s overall capital.

Example of ROCE

Consider two companies that operate in the same industry: ACE Corp. and Sam & Co. The table below shows a hypothetical ROCE analysis of both companies.

As you can see, Sam & Co. is a much larger business than ACE Corp., with higher revenue, EBIT, and total assets. However, when using the ROCE metric, you can see that ACE Corp. is more efficiently generating profit from its capital than Sam & Co. ACE ROCE is 44 cents per capital dollar or 43.51% vs. 15 cents per capital dollar for Sam & Co., or 15.47%.

The Bottom Line

There are a number of different financial metrics that help analysts and investors review the financial health and well-being of different companies. You can use a company's return on capital employed to determine how profitable it is and how efficiently it uses its capital. You can easily calculate it using figures from corporate financial statements. But be sure to compare the ROCE of companies within the same industry as those from different sectors tend to have varying ratios. But it's generally a given that having a ratio of 20% or more means that a company is doing well.