Return on capital employed

From Wikipedia, the free encyclopedia

This article may require cleanup to meet Wikipedia's quality standards.
Please discuss this issue on the talk page or replace this tag with a more specific message.
This article has been tagged since March 2006.

Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is realizing from its capital employed. The ratio can also be seen as representing the efficiency with which capital is being utilized to generate revenue. It is commonly used as a measure for comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital.

1 The formula
2 Drawbacks of ROCE
3 Additional and alternative definitions
4 See also
5 References

[edit] The formula

$ROCE\ =\ \frac{Pretax\ operating\ profit}{Capital\ employed}\ =\ \frac{EBIT}{Total\ assets - Current\ liabilities}$

ROCE compares earnings with capital invested in the company. It is similar to Return on Assets, but takes into account sources of financing. In the denominator we have net assets or capital employed instead of total assets (which is the case of Return on Assets). In the numerator we have Pretax operating profit or EBIT.

Capital Employed has many definitions. In general it is the capital investment necessary for a business to function. It is commonly represented as total assets less current liabilities or fixed assets plus working capital.

[edit] Drawbacks of ROCE

The main drawback of ROCE is that it measures return against the book value of assets in the business. As these are depreciated the ROCE will increase even though cash flow has remained the same. Thus, older businesses with depreciated assets will tend to have higher ROCE than newer, possibly better businesses. In addition, while cash flow is affected by inflation, the book value of assets is not. Consequently revenues increase with inflation while capital employed generally does not (as the book value of assets is not affected by inflation).

[edit] Additional and alternative definitions

A different way to calculate ROCE is ROACE, Return on AVERAGE Capital Employed. Instead of using the capital as reported, it uses the average of opening and closing capital for the time period.