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Encyclopedia > Return on Capital Employed

Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is realising from its capital employed. 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. The field of finance refers to the concepts of time, money and risk and how they are interelated. ... Returns, in economics and political economy, are the distributions or payments awarded to the various suppliers of the factors of production. ... The assets within a managers direct span of control. ...

Contents

The formula

Different authors use different definitions for the terms.[1] A common definition is:

or Roce = profit before tax / capital employed * 100


ROCE compares earnings with capital invested in the company. It is similar to Return on Assets (ROA), but takes into account sources of financing. This article does not cite any references or sources. ...


Operating Income

In the numerator we have Pretax operating profit or operating income. In the absence of non-operating income, operating income agrees with EBIT; otherwise, it can be derived from EBIT by subtracting non-operating income. EBIT stands for Earnings before Interest and Taxes (operating income). ... Earnings before interest and taxes (EBIT), also known as operating income and operating profit, is a term used to describe a companys earnings. ...


Capital Employed

In the denominator we have net assets or capital employed instead of total assets (which is the case of Return on Assets). 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.


ROCE uses the reported (period end) capital numbers; if one instead uses the average of the opening and closing capital for the period, one obtains Return on Average Capital Employed (ROACE).


Application

ROCE is used to prove the value the business gains from its assets and liabilities, a business which owns lots of land but has little profit will have a smaller ROCE to a business which owns little land but makes the same profit.


It basically can be used to show how much a business is gaining for its assets, or how much it is losing for its liabilities.


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).


See also

Cash flow return on investment is a valuation model that assumes the stock market sets prices based on cash flow, not on corporate performance and earnings. ... It has been suggested that this article or section be merged with Return on capital. ... Return on Equity (ROE, Return on average common equity) measures the rate of return on the ownership interest (shareholders equity) of the common stock owners. ... This article does not cite any references or sources. ... Economic Value Added (EVA) is an estimate of true economic profit after making corrective adjustments to GAAP accounting, including deducting the opportunity cost of equity capital. ...

References

  1. ^ Financial Ratio Analysis - Return on Capital Employed Ratio

  Results from FactBites:
 
Examining Accounts: Business Ratios: Return on Capital (596 words)
The ratio is referred to either as return on capital employed, return on investment or return on net assets and is calculated as follows.
Capital employed is total assets less current liabilities as shown in the balance sheet.
A variation of return on capital employed is return on tenants capital which can be a useful ratio to consider where the trade is farming.
  More results at FactBites »

 
 

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