Loading the player...

What is 'Return On Capital Employed (ROCE)'

Return on capital employed (ROCE) is a financial ratio that measures a company's profitability and the efficiency with which its capital is employed. ROCE is calculated as:

ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed

Components of 'Return On Capital Employed (ROCE)'

ROCE is a useful metric for comparing profitability across companies based on the amount of capital they use. There are two metrics required to calculate the Return on Capital Employed - earnings before interest and tax and capital employed. Earnings before interest and tax (EBIT), also known as operating income, shows how much a company earns from its operations alone without regard to interest or taxes. EBIT is calculated by subtracting cost of goods sold and operating expenses from revenues.

Capital employed is the total amount of capital that a company has utilized in order to generate profits. It is the sum of shareholders' equity and debt liabilities. Also, it can be simplified as total assets minus current liabilities. Instead of using capital employed at an arbitrary point in time, analysts and investors often calculate ROCE based on the average capital employed, which takes the average of opening and closing capital employed for the time period.

Practical Example of ROCE

Consider two companies, Colgate-Palmolive Company and Procter & Gamble, which operate in the same industry sector. The table below shows the ROCE of both companies for fiscal year ended December 31, 2016 and June 30, 2017, respectively.

(in millions) Colgate-Palmolive Company Procter & Gamble  
Sales $15,195 $65,058  
EBIT $3,837 $13,955  
Total Assets $12,123 $120,406  
Current Liabilities $3,305 $30,210  
Capital Employed $8,818 $90,196 TA - CL
Return on Capital Employed 0.4351 0.1547 EBIT/Capital Employed

Instead of just looking at the revenue generated by each company, the capital employed by both companies should be compared. Although Procter & Gamble had more sales for the year and more assets, in terms of value, Colgate-Palmolive's ROCE of 43.51% is higher than P&G's 15.47% ROCE. This means that Colgate-Palmolive does a s better job of deploying its capital than P&G. A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value.

Using the Return on Capital Employed

ROCE is 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 common equity, ROCE considers debt and other liabilities as well. This provides a better indication of financial performance for companies with significant debt.

Adjustments may sometimes be required to get a truer depiction of ROCE. A company may occasionally have an inordinate amount of cash on hand, but since such cash is not actively employed in the business, it may need to be subtracted from the Capital Employed figure to get a more accurate measure of ROCE.

For a company, the ROCE trend over the years is also an important indicator of performance. In general, investors tend to favor companies with stable and rising ROCE numbers over companies where ROCE is volatile and bounces around from one year to the next.

Read more on how ROCE can be an effective analysis tool - Spotting profitability with ROCE.

RELATED TERMS
  1. Special Employer

    A special employer is an employer who receives an employee on ...
  2. Terms of Employment

    Terms of employment are conditions that an employer and employee ...
  3. Capital Investment

    Capital investment refers to funds invested in a firm or enterprise ...
  4. Return On Invested Capital - ROIC

    Return on invested capital (ROIC) is a way to assess a company's ...
  5. Corporate Capital

    Corporate capital refers to the assets a business has available ...
  6. Gross Working Capital

    Gross working capital is the sum of all of a company's current ...
Related Articles
  1. Trading

    Find Quality Investments With ROIC

    Return on invested capital is a great way to measure the true value produced by a company. Learn to use the ROIC metric and increase your chances of finding successful investments.
  2. Taxes

    EBIT (Earnings Before Interest and Taxes)

    Earnings before interest and taxes, or EBIT, takes a company’s revenue, or earnings, and subtracts its cost of goods sold and operating expenses.
  3. Investing

    Colgate-Palmolive Trades Ex-Dividend Wednesday

    Colgate-Palmolive will send its dividend payment on May 15 to shareholders of record as of April 21.
  4. Retirement

    Employers: Don't Forget IRS Form 941

    Your obligations as an employer include various employment taxes. Use this form to report them.
  5. Investing

    Calculating Days Working Capital

    A company’s days working capital ratio shows how many days it takes to convert working capital into revenue.
  6. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  7. Personal Finance

    Employability, the Labor Force and the Economy

    Learn how employability is affected by market and economic conditions. Find out how soft, hard, and technical skills affects a person's employability.
  8. Investing

    Evaluating a Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  9. Managing Wealth

    Issued share capital versus subscribed share capital

    Learn the difference between issued share capital versus subscribed share capital. Get information about various types of capital.
  10. Investing

    Will Procter & Gamble's Restructuring Pay Off?

    Procter & Gamble has whittled down its brand portfolio from 160 to 65. Will this strategy pay off?
RELATED FAQS
  1. What is the difference between ROCE and ROA?

    Understand the difference between the profitability ratios of return on capital employed and return on assets, and learn ... Read Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
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