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Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in
finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corn ...

finance
, valuation and
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, as a measure of the profitability and value-creating potential of companies relative to the amount of capital invested by shareholders and other debtholders.Fernandes, Nuno. Finance for Executives: A Practical Guide for Managers. NPV Publishing, 2014, p. 36. It indicates how effective a company is at turning capital into profits. The ratio is calculated by dividing the after tax
operating income In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compar ...
(
NOPAT In corporate finance Corporate finance is the area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and ...
) by the average book-value of the
invested capitalNet operating assets (NOA) are a business's operating Asset, assets minus its operating Liability (financial accounting), liabilities. NOA is calculated by reformatting the balance sheet so that operating activities are separated from financing activ ...
(IC).


Return on invested capital formula

ROIC = \frac There are three main components of this measurement that are worth noting: * While ratios such as
return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to the equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, eq ...
and
return on assetsThe return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue. ROA can be computed as below: :\mathrm = \frac This number tells you what the company can do with what it has, ''i.e.'' how many dolla ...
use net income as the numerator, ROIC uses net operating income after tax (NOPAT), which means that after-tax expenses (income) from financing activities are added back to (deducted from) net income. * While many financial computations use market value instead of book value (for instance, calculating debt-to-equity ratios or calculating the weights for the
weighted average cost of capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by t ...
(WACC)), ROIC uses book values of the
invested capitalNet operating assets (NOA) are a business's operating Asset, assets minus its operating Liability (financial accounting), liabilities. NOA is calculated by reformatting the balance sheet so that operating activities are separated from financing activ ...
as the denominator. This procedure is done because, unlike market values which reflect future expectations in efficient markets, book values more closely reflect the amount of initial capital invested to generate a return. * The denominator represents the average value of the
invested capitalNet operating assets (NOA) are a business's operating Asset, assets minus its operating Liability (financial accounting), liabilities. NOA is calculated by reformatting the balance sheet so that operating activities are separated from financing activ ...
rather than the value of the end of the year. This is because the NOPAT represents a sum of money flows, while the value of the invested capital changes every day (e.g., the invested capital on December 31st could be 30% lower than the invested capital on December 30th). Because the exact average is difficult to calculate, it is often estimated by taking the average between the IC at the beginning of the year and the IC at the end of the year. Some practitioners make an additional adjustment to the formula to add depreciation, amortization, and depletion charges back to the numerator. Since these charges are considered "non-cash expenses" which are often included as part of operating expenses, the practice of adding these back is said to more closely reflect the cash return of a firm over a given period of time. However, others may argue that these non-cash charges should remain left out of the formula as they reflect the decline in the useful life of certain assets in the denominator.


Relationship with WACC

Because financial theory states that the value of an investment is determined by both the amount of and risk of its expected cash flows to an investor, it is worth noting ROIC and its relationship to the
weighted average cost of capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is commonly referred to as the firm's cost of capital. Importantly, it is dictated by t ...
(WACC). The cost of capital is the return expected from investors for bearing the risk that the projected cash flows of an investment deviate from expectations. It is said that for investments in which future cash flows are incrementally less certain, rational investors require incrementally higher rates of return as compensation for bearing higher degrees of risk. In corporate finance, WACC is a common measurement of the minimum expected weighted average return of all investors in a company given the riskiness of its future cash flows. Since return on invested capital is said to measure the ability of a firm to generate a return on its capital, and since WACC is said to measure the minimum expected return demanded by the firm's capital providers, the difference between ROIC and WACC is sometimes referred to as a firm's "excess return", or "
economic profit An economic profit is the difference between the revenue a commercial entity has received from its outputs and the opportunity cost In Microeconomics, microeconomic theory, opportunity cost is the loss of the benefit that ''could'' have been en ...
".


See also

*
Cash flow return on investmentCash-flow return on investment (CFROI) is a Valuation (finance), valuation model that assumes the stock market sets prices based on cash flow, not on corporate performance and earnings. :\text = \frac For the corporation, it is essentially intern ...
(CFROI) *'' Fairfield Plaza, Inc. v. Commissioner'' *
Negative return (finance) The term negative return is used in business or finance to describe a loss, i.e., a negative return on investment. By extension the term is also used for a project that is not worthwhile, even in a non-economic sense. Profit Negative concepts { ...
*
Profit maximization In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods an ...

Profit maximization
*
Profitability An economic profit is the difference between the revenue a has received from its outputs and the s of its inputs. Unlike an , an economic profit takes into account both a 's and costs, whereas an accounting profit only relates to the explici ...
*
Rate of profit In economics and finance, the profit rate is the relative Profit (accounting), profitability of an investment project, a capitalist enterprise or a whole capitalist economy. It is similar to the concept of rate of return on investment. Historical ...
*
Rate of return on a portfolioThe rate of return on a portfolio is the ratio of the net gain or loss (which is the total of net income, foreign currency appreciation and capital gain, whether realized or not) which a portfolio generates, relative to the size of the portfolio. It ...
*
Recovery of capital doctrineIn United States tax law the recovery of capital doctrine protects a portion of investment receipts from being taxed, namely the amount that was initially invested. This is because the investor is receiving his or her own money which is being returne ...
*
Return on assetsThe return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue. ROA can be computed as below: :\mathrm = \frac This number tells you what the company can do with what it has, ''i.e.'' how many dolla ...
(RoA) *
Return on brandThe return on brand (ROB) is an indicator used to measure brand management performance. It is an indicator of the effectiveness of brand use in terms of generating net income. In fact, it is a special case of return on assets (ROA). ROB is calculate ...
(ROB) *
Return on capital employed Return on capital employed is an accounting ratio used in finance, valuation, and accounting. It is a useful measure for comparing the relative profitability of companies after taking into account the amount of capital used.Fernandes, Nuno. Finance ...
(ROCE) *
Return on net assetsThe return on net assets (RONA) is a measure of financial performance of a company which takes the use of assets into account. Higher RONA means that the company is using its assets and working capital efficiently and effectively. RONA is used by inv ...
(RoNA) *
Tendency of the rate of profit to fall The tendency of the rate of profit to fall (TRPF) is a theory in the crisis theory Crisis theory, concerning the causes and consequences of the tendency for the rate of profit to fall in a capitalist system, is associated with Marxian cri ...


References

{{Financial ratios Financial ratios