Return On Capital Employed (ROCE)
Return on capital employed (ROCE) is a measure of how much money a company makes from its capital investments. It is typically expressed as a percentage and compares the operating profitability of a firm to the amount of capital employed in its operation. Generally, the higher the ROCE, the better the company is managing its investments and operations.
The general formula for calculating return on capital employed is as follows:
ROCE = Operating Profits / Capital Employed
Operating profit is defined as revenue minus operating expenses, excluding taxes, interest, and depreciation charges. Capital employed is generally defined as the sum of non-current assets (such as machinery, equipment, and property), current assets (like cash), and net debt (which is total liabilities minus cash).
Let's look at an example of a company with the following values:
- Revenue: $2,000,000
- Operating Expenses: $1,200,000
- Non-Current Assets: $1,800,000
- Current Assets: $500,000
- Net Debt: $700,000
In this instance, the operating profits are equal to the difference between revenue and operating expenses, so they are equal to $800,000. The capital employed is the sum of non-current assets, current assets, and net debt, which works out to $2,500,000.
The ROCE in this example would be calculated as follows:
ROCE = $800,000 / $2,500,000 = 0.32 = 32%
This ROCE figure indicates that the company made 32 cents in after-tax profits on every dollar of capital employed.
ROCE is a useful measure of evaluating a company's operational performance and its ability to generate profits from capital investments. It is especially important for companies who utilize debt financing for their operations to monitor their ROCE, as it can indicate how well the company is managing its debt. Additionally, ROCE can be used to compare the performance of companies with different capital structures, as it takes into account the difference amount of debt financing each company has.
ROCE is an important tool for understanding a company's financial performance and health. High ROCE numbers indicate the business is being managed efficiently and is generating higher returns in comparison to the capital employed. Low ROCE numbers indicate that improvements could be made in how the business is managed. Ultimately, ROCE is an important metric to monitor and measure a company's performance, as it can indicate how well the company is managing its capital investments and overall financial health.
Another important measure of economic performance is Return on Equity (ROE). Although it is similar concept to ROCE, the two metrics differ in that ROE is the amount of income earned with the shareholders' equity while ROCE measures income generated with total capital employed, which includes debt financing.
Additionally, ROE measures the profitability of shareholders while ROCE assesses the returns based on all financiers, including those involved in loan and debt financing.
Return on investment (ROI) is another financial metric that measures the profitability of an investment. However, while ROCE measures profitability on debt-financed investments, ROI measures the profitability of a particular investment or asset.
For example, the ROI on a machine used in a manufacturing process would be the after-tax profits generated by the machine on the capital invested in the machine. The ROI is a much more granular metric, as it is focused on a specific investment, while ROCE is more general and focused on all parts of the business.