Return on employed capital
Return on employed capital or, more strictly, return on capital employed (ROCE) is a ratio which informs us about the profitability of investments in which the fixed capital of the company is engaged. Thanks to it, we can measure how efficient is the company and compare it with others. The situation when the cost of capital is higher than ROCE means that the company operates inefficiently and is not valuable for shareholders.
How do you calculate return on capital employed?
As we have already explained what is return on employed capital, we can go to the next step. Perhaps you ask: Oh, right, then how do you calculate return on capital employed? Don’t worry, we will make it clear.
The ROCE formula is simple. It includes two components: EBIT, which can show how much the company earns from the investment before taxes and interests, and the whole capital utilized by the company. When we have these two variables, we can calculate ROCE using the following formula:
ROCE = EBIT / fixed capital * 100
Now, having the ROCE formula, we can consider an example:
- EBIT: 20,500 $
- Fixed capital: 114,890 $
Using the data above, you can get ROCE by – according to what we have already explained – dividing EBIT by the fixed capital:
ROCE = 20,500 / 114,890 * 100% = 17,843 %
Importance of return on capital employed
We have already discussed a few business indicators and, to be honest, each of them should be deemed important. Actually, none of them has been created without a reason. So… what is the importance of return on capital employed?
ROCE is an important ratio because, as opposed to ROE which considers only equity, it analyses the whole capital of the company. It’s useful especially in companies which belong to capital-intensive sectors, such as utilities or telecommunication, as it makes it possible and more effective to analyze the activity of companies with a significant level of debt.