ROCE Formula: Understanding its Calculation, Examples, and Limitations Return on Capital Employed

Last Updated : May 6, 2023, 3:06 p.m.

Return on Capital employed, commonly known as ROCE, allows an analysis of a company’s profitability and capital efficiency. Various ROCE formulae are used to derive and conclude the profits generated by the company through its capital use. ROCE constitutes one of the many factors of investment, like stakeholders, potential investors, and financial managers of the firm. It is an essential factor for the company’s stable performance. The ROCE formula helps you get an exact idea of the performance of the company. This article aims to define the financial statistic of ROCE.

What Does ROCE Say About the Company?

The ROCE of the company, calculated through a ROCE formula, tells the traders about the efficient utilisation of capital by that firm. A high ROCE score obtained through a ROCE formula indicates that capital utilisation is well, and a low score indicates a lack of capital use. It is considered an indicator of long-term, high profitability. The ROCE score can also assist traders in analysing the performance trend of a particular company. It holds a mirror to the effective management and expandability of the company. No specific number is obtained by using the ROCE formulae that are considered the bar. However, the higher the score, the better it is.

A ROCE score of 20% and above is a good indicator of financial performance.

Calculation of ROCE

In the previous sections, you read about the ROCE formula. Here, you will learn to implement it.

The ROCE formula is ROCE = EBIT / Capital Employed

Here,

• ROCE is the Return on Capital Employed.
• EBIT is the Earning Before Interest and Tax. It includes all the expenses of the company except for tax and interest expenses.
• Capital employed is the difference between current liabilities and total interest. It can also be the sum of working capital and fixed assets. It is the total amount of equity invested in that particular business.

With the help of the ROCE formula mentioned above, you can calculate and assess a company’s capital utilisation within a particular time frame.

Examples of ROCE Calculation

Below are two examples for your reference to better understand the ROCE formula.

Example 1

The company had a net operating profit of 10 million rupees in 2019. As of the balance sheet date, its total assets and current liabilities were 130 million rupees and 70 million rupees, respectively. Determine the company’s ROCE for the year using the information provided above.

According to the ROCE formula mentioned above,

ROCE = EBIT / Capital Employed

ROCE = EBIT / (Total Assets – Current Liabilities)

ROCE = 10 million rupees / (130 million rupees – 70 million rupees)

ROCE = 0.1666 million rupees

This implies that the Return on Capital Employed by the ROCE formula was 16.66% in the year 2016 for this company.

Example 2

We will see one more similar example that will help you better understand how to use the ROCE formula.

As of August 2021, the company’s total assets and total current liabilities were 362.43 billion rupees and 114.38 billion rupees, respectively, according to the annual report. The operating income for the year was reported as being 68.46 billion. Calculate the business’s ROCE for 2015 using the information provided.

If we apply the ROCE formula here,

ROCE = EBIT / Capital Employed

ROCE = EBIT / (Total Assets – Current Liabilities)

This implies ROCE = 68.46 billion rupees / (362.43 billion rupees – 114.38 billion rupees)

ROCE = 0.2759

We conclude that, according to the ROCE formula, the return on capital employed for this company was 27.59%.

Note down your company’s EBIT, Total Assets and Current Liabilities to calculate Capital Employed. Next, use the formula to calculate the ROCE.

Significance of Return on Capital Employed (ROCE)

If an investment decision needs to be made, ROCE is calculated by using the ROCE formula. This score gives an idea of the functioning and ability of the company to the investors or traders.

• The investors compare the ROCE scores of different firms or companies before investing. Through this, they get a vision of which firm might create returns most efficiently and effectively.
• ROCE is also efficient in measuring the financial profitability for you as an investor.
• It helps you to compare firms in the same sector for better investments and returns by calculating ROCE scores through ROCE formulae .

Limitations of Return on Capital Employed (ROCE)

ROCE has its limits despite all the advantages it possesses. Below are some of the restrictions of ROCE –

• The precision of the scores while comparing different firms might be hindered, despite applying the ROCE formula correctly.
• Since ROCE only gives data on the company’s capital usage, using it as a single performance metric is unproductive.
• ROCE is not accurate in case a company has a cash reserve. They will have a lower ROCE score despite having good capital utilisation.
• It is challenging to keep track of ROCE scores throughout. They change every year and thus are hard to keep track of.

Conclusion

Like everything in the world, the return on capital employed has its share of advantages and disadvantages. While it is an essential tool for knowing better about investing in a company, it might sometimes be ineffective. Using ROCE formulae makes it easy to calculate the score for a better investment.

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