Return on Capital Employed

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#### Example:

Calculate the annual RoCE of The Portland Foodie Bookstore, when:

• Average stockholder equity = \$348,000
• Average capital employed = \$120,000
• Annual net operating profit = \$49,000

RoCE = average equity ÷ capital employed 49,000 ÷ (348,000 + 120,000) = 0.105 =10%

#### Return on Capital Employed Definition

This ratio measures a company’s profitability. It is calculated as net operating profit of a company divided by its capital used during a specific time period. It is similar to the return on assets ratio. But, it also takes sources of financing into account. In short, RoCE measures the result of its operations (profit) as a percentage of the capital needed to achieve it.

The main drawback of RoCE is that it measures a return against the book value of assets in the business. Because assets are depreciated, the RoCE can increase even if cash flow remains the same.

NOTES:

• Capital employed = long-term stockholder equity + long-term financing = total assets - current liabilities
• Some analysts use earnings before interest and tax (EBIT) instead of net profit when they calculate RoCE.

#### Analysis

Analysts consider higher RoCE values as a favorable indicator of a strong business. Companies with higher RoCE values generate more earnings per dollar of capital used. Lower values indicate lower profitability. ROCE should always be higher than the rate at which a company borrows. Otherwise, any increase in borrowing will reduce shareholders' earnings. Companies having lower asset values but the same profit as its competitors will have higher RoCE values and therefore be more profitable.

RoCE is used to show the value a business gains from its assets and liabilities. A business which owns lots of land will have a smaller RoCE compared to a business that owns little land but makes the same profit.

RoCE = Net operating profit ÷ capital employed