Return on Capital Employed

Return on capital employed

Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is realizing from its capital employed. ROCE should always be higher than the rate at which the company borrows

The formula

Capital Employed
ROCE compares earnings with capital invested in the company. It is similar to Return on Assets (ROA), but takes into account sources of financing.

Earnings before interest and taxes 

In accounting and finance, earnings before interest and taxes (EBIT) or operating income is a measure of a firm's profitability that excludes interest and income tax expenses.[1]
EBIT = Operating Revenue – Operating Expenses (OPEX) + Non-operating Income
Operating Income = Operating Revenue – Operating Expenses[1]
Operating income is the difference between operating revenues and operating expenses, but it is also sometimes used as a synonym for EBIT and operating profit.[2] This is true if the firm has no non-operating income.

Capital Employed

In the denominator we have net assets or capital employed instead of total assets (which is the case of Return on Assets). Capital Employed has many definitions. In general it is the capital investment necessary for a business to function. It is commonly represented as total assets less current liabilities or fixed assets plus working capital.
Capital employed = total assets
Capital employed = fixed assets + current assets - current liabilities


ROCE is used to prove the value the business gains from its assets and liabilities, a business which owns lots of land but has little profit will have a smaller ROCE to a business which owns little land but makes the same profit.
It basically can be used to show how much a business is gaining for its assets, or how much it is losing for its liabilities.


Advantages of ROCE

· The main drawback of ROCE is that it measures return against the book value of assets in the business. As these are depreciated the ROCE will increase even though cash flow has remained the same.
· It does not signal for investment like NPV.
· Simplicity
· Link with other accounting measure

Disadvantages of ROCE

· It does not consider project life/timing of cash flows
· It will vary with specific accounting policies
· It does not signal for investment
Copyright © STUDY FOR BUSINESS - Blogger Theme by Logics IT & Technology