ROCE Calculator
Learn how to increase the return on capital employed with CalcoPolis.
Table of Contents
- What does return on capital employed mean?
- How to calculate the return on capital employed?
- Return on Capital Employed formula
- EBIT
- Capital Employed
- Return on Average Capital Employed (ROACE)
- When to use a Return on Capital Employed calculator?
- How to use ROCE to calculate the efficiency of capital employed?
- How to use ROCE for company valuation?
- How to use ROCE to determine if a company could receive additional funds?
- How to use ROCE to benchmark companies?
- ROCE is not a universal metric
- ROCE undermines long-term investments
- Startups usually have low ROCE
- What is a good ROCE ratio?
- Example ROCE calculation
- Alternative calculators
What does return on capital employed mean?
ROCE is a business indicator that measures how well a company generates profit from its working capital. In other work, this metric tells how profitable a company is.
There are many similar financial metrics. Some of them differ slightly from ROCE and are often misunderstood. In this article, we will explain all the nuances and differences between ROCE and its alternatives, such as Return on Invested Capital, Return on Assets, and Return on Equity.
Characteristics
- ROCE gives information on how much profits a company generates using its capital.
- Capital Employed represents the company's total assets minus short-term liabilities.
- ROCE is a metric very similar to ROIC.
- ROCE should be higher than the Weighted Average Costs of Capital in order to be considered a good value generator.
How to calculate the return on capital employed?
Return on Capital Employed formula
ROCE = (EBIT / Capital_Employed) * 100%
Where:
EBIT
Earnings Before Interest and Taxes, also known as operating income, represents how much a company earns on its regular business before interests and taxes are deducted.
Capital Employed
Simply, it's the total capital put to work by the company; it can be calculated by subtracting current liabilities from the company's total assets.
Capital Employed = total_assets - current_liabilities
From the accounting perspective, the formula above is an equivalent of shareholders' equity and long-term debts.
Capital Employed = shareholders’ equity + long-term debts
Return on Average Capital Employed (ROACE)
Some investors prefer a slightly different approach for determining the value of ROCE and use the average capital employed, the arithmetic average of capital employed at the beginning and end of the analyzed period.
Average Capital Employed = (Starting Capital + Ending Capital) / 2
And now, we can derive the ROACE formula:
ROACE = (EBIT / Average Capital Employed) * 100%
Key takeaways from the equations
- ROCE can be increased either by an increase in EBIT
- High long-term debts can reduce the ROCE ratio if the money is not used efficiently
When to use a Return on Capital Employed calculator?
Return on Capital Employed is an advanced financial metric and, if calculated correctly, can provide a good overview of a company's efficiency in turning invested capital into profits.
ROCE can be used interchangeably with other similar metrics. For more details, you could visit our ROIC calculator or ROA calculator.
How to use ROCE to calculate the efficiency of capital employed?
ROCE is a good metric of company efficiency in utilizing available resources for generating profits. In order to interpret its value correctly, it's important to know that since ROCE ignores short-term liabilities, it is meant to analyze the prospects of long-term financing.
How to use ROCE for company valuation?
Calculating ROCE is an important component of the fundamental analysis of the enterprise, but not the only one. Since many factors impact a company's profitability and prospects of further growth, other metrics should also be applied to determine the business's real value.
How to use ROCE to determine if a company could receive additional funds?
Two main methods of acquiring additional financing for the company are rising debt or selling shares. However, each option has its pros and cons. One fundamental question needs to be asked before increasing company funds: "will the company be able to create more value with more funding at the extra cost?"
This could be determined by comparing ROCE to the Weighted Average Cost of Capital (WACC). If ROCE is higher than WACC, extra funds could be turned into profits.
How to use ROCE to benchmark companies?
Return on Capital Employed can be applied for comparison of the companies. Especially to determine how well they utilize the available capital.
However, it shouldn't be used to analyze companies' financial performance from different industries. Since the structure of the businesses is radically different.
The best approach to this task is to compare their ROCE with the benchmark value for the industry.
Limitations of ROCE
Below we discuss situations when you should be cautious about the ROCE indicator.
ROCE is not a universal metric
By performing ROCE calculation, you can find useful information about a company, trends, and prospects for raising new funding. However, it doesn't provide detailed information about individual components of the enterprise.
ROCE undermines long-term investments
Similarly, as in the case of ROIC, this financial ratio ignores the investments yet to bring profits. So if the company is involved with long-term projects that are about to generate income many years into the future, ROIC calculation will not reveal the full potential of the company.
Startups usually have low ROCE
For similar reasons, recently founded companies have low or negative ROCE ratios. Investments need time before they start to bring profits, and analyzing this metric in the first years of the business is not always the right approach.
What is a good ROCE ratio?
There is no simple answer to that question since much depends on the market segment. The best way of determining what a good ROCE value is is to check benchmarks for the entire industry and compare them with a company's ROCE.
Since the intent of the ROCE metric is to analyze efficiency in utilized available capital by comparing ROCE with the weighted average cost of capital (WACC), investors can tell if ROCE is high enough to justify further investments into the company.
Example ROCE calculation
Calculating ROCE is fairly easy since all the needed information is available in the balance sheet and income statement. The only thing you need to do is to substitute the values into the ROCE equation.
Let's calculate ROCE for Apple Inc. (AAPL). In fiscal year 2021 Apple generated EBIT $111,852,000,000.
The company has average capital employed equal to $222,000,000,000, so the return on capital employed can be calculated as follows:
ROCE = (EBIT / Avg. Capital Employed) * 100% = $111,852,000,000 / $222,000,000,000 * 100% = 50,4%
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Alternative calculators
CalcoPolis also provides other financial tools that can be applied to analyze company efficiency. For more details, visit our other pages like ROA calculator and ROIC calculator.
If you are looking for more basic metrics, you can visit our ROI calculator or ROE calculator.
Authors
Created by Lucas Krysiak on 2022-04-13 16:25:42 | Last review by Mike Kozminsky on 2022-09-15 13:51:52