Return on capital employed or ROCE is a profitability ratio that measures how efficiently a company can generate profits from its capital employed by comparing net operating profit to capital employed.
In other words, return on capital employed shows investors how many dollars in profits each dollar of capital employed generates.
Investing in stocks is not very difficult and one can learn it through experience or take the guidance of stock market experts and equity advisors.
You have to analyze a company both on a fundamental and technical basis to understand the stock price movement and also check the background of the company, analyze the financial strength, compare profitability ratios of various companies before choosing to invest in a company.
Some of the profitability ratios are return on assets, return on equity, ROCE, etc. Let us try to learn about return on capital employed ratio and its significance.
What is Return on Capital Employed?
Return on capital employed (ROCE) is a financial ratio that can be used in assessing a company’s profitability and capital efficiency. In other words, the ratio can help to understand how well a company is generating profits from its capital.
The ROCE ratio is one of several profitability ratios financial managers, stakeholders, and potential investors may use when analyzing a company for investment.
How to Calculate the Return on Capital Employed
Return on capital employed formula is easy and anyone can calculate this to measure the efficiency of the company in generating profit using capital.
The formula for ROCE is as follows:
ROCE= EBIT/Capital Employed
EBIT=Earnings before interest and tax
Capital Employed=Total assets − Current liabilities
What is difference between ROCE and ROE?
ROE considers profits generated on shareholders’ equity, but ROCE is the primary measure of how efficiently a company utilizes all available capital to generate additional profits.
The long-term ROCE is also an important indicator of performance.
What is a good return on capital employed?
The higher your ROCE is, the better. This is because a higher ROCE indicates that a higher percentage of your company’s value may be returned to stakeholders as profit. So, what is a good return on capital employed? Although a “good ROCE” varies depending on the size of your company, in general, the ROCE should be double the current interest rates at the very least.
What does higher return on capital mean?
Companies with higher roce in share market indicate that these companies employ capital in an efficient manner thereby generating higher profits.
It also shows that the company’s cash flow is strong. Investors should analyze ROCE of a company for several years as there should be a consistency in it.
ROCE also depends on various factors such as the sector to which the company belongs to, the age and size of the company, etc.
In the final analysis, it can be said that ROCE is one of the best profitability ratios to consider while the investors decide upon the company’s profitability. But you need to keep in mind that it is not the only profitability ratio to consider.
You can also take into account several ratios like Profit Margins, Return on Invested Capital (ROIC), Return on Asset (ROA), Interpret ROE, etc.