Return on capital employed
Encyclopedia
Return on capital employed is a ratio used in finance, valuation, and accounting.
ROCE compares earnings with capital invested in the company. It is similar to Return on Assets (ROA), but takes into account sources of financing. NOPAT
is equal to EBIT * (1 - tax) -- the return on the capital employed should be measured in after tax terms.
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
.
ROCE uses the reported (period end) capital numbers; if one instead uses the average of the opening and closing capital for the period, one obtains Return on Average Capital Employed (ROACE).
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.
The formula
ROCE compares earnings with capital invested in the company. It is similar to Return on Assets (ROA), but takes into account sources of financing. NOPAT
NOPAT
In corporate finance, net operating profit after tax or NOPAT is a company's after-tax operating profit for all investors, including shareholders and debt holders. It is equal to NOPLAT and is defined as follows:An alternative formula is as follows...
is equal to EBIT * (1 - tax) -- the return on the capital employed should be measured in after tax terms.
Operating Income
In the numerator we have NET OPERATING PROFIT AFTER TAX, ie. operating profit or EBIT less tax less non-operating items.Capital Employed
In the denominator we have net assets or capital employedCapital employed
Capital employed has many definitions. In general, it represents the capital investment necessary for a business to function. Consequently, it is not a measure of assets, but of capital investment: stock or shares and long-term liabilities.- Definitions :...
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
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
less current liabilities or fixed assets plus working capital
Working capital
Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is...
.
ROCE uses the reported (period end) capital numbers; if one instead uses the average of the opening and closing capital for the period, one obtains Return on Average Capital Employed (ROACE).
Application
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.
Drawbacks 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. Thus, older businesses with depreciated assets will tend to have higher ROCE than newer, possibly better businesses. In addition, while cash flow is affected by inflation, the book value of assets is not. Consequently revenues increase with inflation while capital employed generally does not (as the book value of assets is not affected by inflation).See also
- Cash flow return on investmentCash flow return on investmentCash flow return on investment is a valuation model that assumes the stock market sets prices based on cash flow, not on corporate performance and earnings.CFROI = Cash Flow / Market Recapitalization...
(CFROI) - Return on Operating Capital (ROOC)
- Return on Invested Capital (ROIC)
- Return on EquityReturn on equityReturn on equity measures the rate of return on the ownership interest of the common stock owners. It measures a firm's efficiency at generating profits from every unit of shareholders' equity . ROE shows how well a company uses investment funds to generate earnings growth...
(ROE) - Return on Assets (ROA)
- Economic Value AddedEconomic value addedIn corporate finance, Economic Value Added or EVA, a registered trademark of Stern Stewart & Co., is an estimate of a firm's economic profit – being the value created in excess of the required return of the company's investors . Quite simply, EVA is the profit earned by the firm less the cost of...
(EVA) - Cash Surplus Value AddedCash Surplus Value AddedCash surplus value added is a measure of business profitability defined as the EBITDA after tax generated by the business less its required return...
(CsVA) index