The return on capital employed (ROCE) ratio, expressed as a percentage, complements the return on equity (ROE) ratio by adding a company's debt liabilities, or funded debt, to equity to reflect a company's total "capital employed". This measure narrows the focus to gain a better understanding of a company's ability to generate returns from its available capital base.
By comparing Earnings Before Interest and Tax (EBIT) or net operating profit to the sum of a company's debt and equity capital, investors can get a clear picture of how the use of leverage impacts a company's profitability. Financial analysts consider the ROCE measurement to be a more comprehensive profitability indicator because it gauges management's ability to generate earnings from a company's total pool of capital.
Formula:
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Variations:
There are various takes on what should constitute the debt element in the ROCE equation, which can be quite confusing. My suggestion is to stick with debt liabilities that represent interest-bearing, documented credit obligations (short-term borrowings, current portion of long-term debt, and long-term debt) as the debt capital in the formula.
There are various takes on what should constitute the debt element in the ROCE equation, which can be quite confusing. My suggestion is to stick with debt liabilities that represent interest-bearing, documented credit obligations (short-term borrowings, current portion of long-term debt, and long-term debt) as the debt capital in the formula.
Commentary:
The return on capital employed is an important measure of a company's profitability. Many investment analysts think that factoring debt into a company's total capital provides a more comprehensive evaluation of how well management is using the debt and equity it has at its disposal. Investors would be well served by focusing on ROCE as a key, if not the key, factor to gauge a company's profitability. An ROCE ratio, as a very general rule of thumb, should be at or above a company's average borrowing rate.
The return on capital employed is an important measure of a company's profitability. Many investment analysts think that factoring debt into a company's total capital provides a more comprehensive evaluation of how well management is using the debt and equity it has at its disposal. Investors would be well served by focusing on ROCE as a key, if not the key, factor to gauge a company's profitability. An ROCE ratio, as a very general rule of thumb, should be at or above a company's average borrowing rate.
Unfortunately, there are a number of similar ratios to ROCE, as defined herein, that are similar in nature but calculated differently, resulting in dissimilar results. First, the acronym ROCE is sometimes used to identify Return On Common Equity, which can be confusing because that relationship is best known as the return on equity or ROE. Second, the concept behind the terms return on invested capital (ROIC) and return on investment (ROI) portends to represent "invested capital" as the source for supporting a company's assets. However, there is no consistency to what components are included in the formula for invested capital, and it is a measurement that is not commonly used in investment research reporting.
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