Return on Capital Employed (ROCE)

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

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

“Cap­i­tal Employed” as shown in the denom­i­na­tor is the sum of share­hold­ers’ equi­ty and debt lia­bil­i­ties; it can be sim­pli­fied as (Total Assets – Cur­rent Lia­bil­i­ties). Instead of using cap­i­tal employed at an arbi­trary point in time, ana­lysts and investors often cal­cu­late ROCE based on “Aver­age Cap­i­tal Employed,” which takes the aver­age of open­ing and clos­ing cap­i­tal employed for the time period.

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. A company’s Prof­it Ratio may be low­er but ROCE could be high­er. ROCE helps to under­stand how well a com­pa­ny man­ages share­hold­ers money.

ROCE is espe­cial­ly use­ful when com­par­ing the per­for­mance of com­pa­nies in cap­i­tal-inten­sive sec­tors such as util­i­ties and tele­coms. This is because unlike 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.

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.