Return on Capital Employed (ROCE)
Return on capital employed (ROCE) is the ratio of net operating profit of a company to its capital employed. It measures the profitability of a company by expressing its operating profit as a percentage of its capital employed. Capital employed is the sum of stockholders' equity and long-term finance. Alternatively, capital employed can be calculated as the difference between total assets and current liabilities. The formula to calculate return on capital employed is:
|ROCE =||Net Operating Profit|
A more accurate value can be calculated by using average capital employed which is the sum of average long-term finance and average stockholders' equity.
Some analysts use earnings before interest and tax (EBIT) instead of net profit while calculating return on capital employed.
Since ROCE includes long-term finance in the calculation, therefore it is more comprehensive test of profitability as compared to return on equity (ROE).
A higher value of return on capital employed is favorable indicating that the company generates more earnings per dollar of capital employed. A lower value of ROCE indicates lower profitability. A company having less assets but same profit as its competitors will have higher value of return on capital employed and thus higher profitability.
The average stockholders' equity and average capital employed of a company during the accounting year ended December 31, 20X2 were $348,000 and $120,000 respectively. The net profit during the period was $49,000. Calculate return on capital employed of the company.
Return on Capital Employed = 49,000 ÷ (348,000 + 120,000) = 10.5%
Written by Irfanullah Jan