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Do You Know Your ROCE?

How Measuring Your Return on Capital Employed is Critical for Financial Health

There are so many ways to measure a company’s financial success: profit margin, return on equity, and return on invested capital.

Return On Capital Employed (ROCE) is a lesser known but equally important financial indicator. ROCE is especially useful for evaluating your company’s macro level financials or other companies to invest in. It’s essential because it goes beyond simple profit margins to specifically assess how well a company runs, conducts its business, and returns value to investors.

ROCE is the total of a firm’s assets and revenues minus current liabilities. The ROCE ratio is simple:

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

The higher the result of the formula, the more efficiently a company is utilizing its capital. If a company’s ROCE has gone up since last year or in the last few years, it indicates a company is going in the right direction. At a minimum, ROCE should exceed the cost of capital (financing costs), or the company can find itself in a bad financial state.

ROCE is especially useful in comparing how different companies in the same industry leverage their capital, particularly in capital-intense industries like energy, auto, and telecommunications that habitually hold a large amount of debt.

Don’t confuse ROCE with ROE (return on equity), even though both are profitability ratios that measure a company’s profitability as related to funds invested. ROE takes profits generated from shareholders’ equity into consideration, as opposed to ROCE, which uses all capital employed including the company’s debt.

ROCE percentage is one of the tools for judging the performance of managers and how effectively they are running a business. It’s a good idea to look at the industry average and the ROCE of competing companies.  The ROCE percentage is one of the few metrics that does allow you to compare across industries and within your industry.

If employed capital is not given in financial statement notes, it can be calculated by subtracting current liabilities from total assets. Watch for poor quality profits, such as the sale of expensive equipment that can’t be repeated regularly, as these can create an artificially high ROCE. Other factors such as leasing versus purchasing equipment can also lead to a slightly higher ROCE.

Despite the value of evaluating a company’s ROCE, it should not be the only factor used for an accurate assessment of financial stability; other probability ratios certainly contribute to the whole picture.  However, knowing your ROCE percentage is important metric for a business owner to keep track.  Your ROCE percentage provides the business owner the return they are getting on their investment in the company.

If you want to learn your ROCE percentage, feel free to reach out to Mike to get a free template at Mike@trilliumfinancial.com.


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