Understanding Return on Capital Employed (ROCE) Ratio

Return On Capital Employed (ROCE) is a long-term profitability ratio that measures how efficiently a company is employing its capital to generate profit. It is calculated by dividing the EBIT (Earnings before Interest and Taxes) by total assets minus total current liabilities.

Many investors looked at ROCE before making investment decisions because ROCE considers the company's Debt and Equity. It is helpful to analyze the performance of the company with its debt. ROCE is expressed in percentage and, it is shown in all screeners and charts throughout the site.

The formula to derive ROCE



EBIT - It is company Net Income that is calculated before deducting Interest and Tax expenses. The abbreviation of EBIT is Earnings before Interest and Tax and, it is found, in the company's Income Statement.

Capital Employed - It is calculated by subtracting Total assets and Total Current Liabilities. In the end, it gives the shareholder's equity and long-term debts value.

Total Assets - Total assets are the total number of assets owned by a person or company. Total assets are reported on a company's balance sheet.

Total Current Liabilities - These are a company's debt obligations that are due to be paid within one year. Some current liabilities are accounts payables, short-term debts, outstanding expenses, etc. Current liabilities are found in the liabilities section of the company's Balance Sheet.

Example of Return on Capital Employed: For the financial year, HCL Technology Limited reported Total assets of the company Rs. 86194 Cr, the Current liabilities Rs. 8729 Cr. and EBIT Rs. 20921.18 Cr.
The ROCE for the company as per the formula [ROCE = EBIT / Total Assets - Total Current Liabilities] is calculated as [20921.18 /( 86194 - 8729) x 100] = 27.00%.

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Key Highlights

Higher Return on Capital Employed (ROCE) is more favorable. ROCE with 15% or higher is considered good.

ROCE is more effective for the companies that operate in capital intensive industries like Telecommunication, automobile manufacturing, steel production, oil production, and refining, etc.,

High ROCE with continuous growth year over year and ROCE higher than the company's debt capital are considered a plus point.

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While looking at ROCE, the following points should also take into consideration:

Investors should look for higher ROCE. Generally, a ROCE of 15% or higher is considered good for most industries.

ROCE is more effective for comparing companies that are part of capital-intensive industries like telecommunications, steel production, transportation sector, etc.,

ROCE is more effective than ROE for analyzing companies in capital-intensive industries because ROE only indicates the profitability relative to shareholder's equity, while ROCE considers companies' debt and equity.

High return on capital employed with continuous growth year-over-year and ROCE higher than the company's debt capital is considered a plus point.

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How to use ROCE effectively

Investors should look for a higher Return on Capital Employed. ROCE with 15% or higher is considered good.

ROCE must be greater than debt capital. If it is less than debt capital it indicates that the company cannot pay its debts by profit generated using capital employed.

While analyzing ROCE, we should look for companies that have positive value as well that the company should be growing for years.

It will be better to consider other financial metrics before making a decision like Return on Equity (ROE), Return on Invested Capital (ROIC), Return on Assets (ROA), Retention Ratio, etc.,

ROCE is useful to compare companies that operate in the same industry.

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