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 for Executives: A Practical Guide for Managers. NPV Publishing, 2014, Chapter 3.]
The formula
: (Expressed as a %)
It is similar to
return on assets (ROA), but takes into account sources of financing.
Capital employed
In the denominator we have net assets or capital employed 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
In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can ...
less
current liabilities
In accounting, current liabilities are often understood as all liabilities of the business that are to be settled in cash within the fiscal year or the operating cycle of a given firm, whichever period is longer.
A more complete definition is t ...
(or
fixed assets
A fixed asset, also known as long-lived assets or property, plant and equipment (PP&E), is a term used in accounting for assets and property that may not easily be converted into cash. Fixed assets are different from current assets, such as cas ...
plus
working capital
Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
requirement).
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. Companies create value whenever they are able to generate returns on capital above the weighted average cost of capital (WACC).
[Fernandes, Nuno. Finance for Executives: A Practical Guide for Managers. NPV Publishing, 2014, p. 37.] A business which owns much land will have a smaller ROCE compared 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
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 investment (CFROI)
*
Cash surplus value added (CsVA) index
*
Economic value added (EVA)
*
Return on assets (ROA)
*
Return on equity
The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on ''a ...
(ROE)
*
Return on invested capital (ROIC)
References
{{Financial ratios
Financial ratios
Yield (finance)