Return on Capital Employed (ROCE) - Definition, Example and Calculation: FKnol.com

Return on Capital Employed (ROCE) is a popular financial ratio which is used to assess the capital efficiency and profitability of a company. Simply put, this figure indicates how well (or bad) a company has deployed its capital to generate earnings. Higher value of the ROCE ratio indicates that the company management has put its capital to good use, while a lower value indicates otherwise.
ROCE ranks among the top financial profitability ratios to assess investment opportunity in a company stock. It is used by investment managers, shareholders, other stakeholders, investors as well as project and financial managers to analyse a company's capital efficiency. It is considered to be one of the best profitability ratios.

Formula to Calculate Return on Capital Employed (ROCE)

Calculation of ROCE ratio is simple.

ROCE=EBIT/Capital Employed

where,
◐ EBIT = Earnings before interest and tax (EBIT) is the company's profit, including all expenses except interest and tax expenses, and
◐ Capital employed is the total amount of equity invested in a business. It is is usually calculated as either (Total Assets minus Total Current Liabilities), or as (Fixed Assets plus Working Capital)

Essentially, the ROCE calculation boils down to - How much earnings the company generated for every dollar of capital it employed?

The following three values are required to compute ROCE:
(1) EBIT - Earnings Before Interest and Tax
(2) Total Assets
(3) Total Current Liabilities

All of the above three are standard items that appear in the financial statements of a company when it reports its quarterly or annual results. For instance, EBIT is available as a standard line item in the Income Statement, while Total Assets and Total Current Liabilities are available in the Balance Sheet.

Example of Return on Capital Employed (ROCE)

In this article, we will look at the following real-world examples of recent times for calculating ROCE.

ROCE Example No. 1:
The NYSE-listed Wal-Mart Stores, Inc. (WMT) belongs to the Consumer Services sector and is categorized under the Department Specialty Retail Stores subsector. Walmart Inc. engages in the retail and wholesale operations in various formats worldwide. The company operates through three segments: Walmart U.S., Walmart International, and Sam's Club. It operates ...Detailed Company Profile.
As per the quarterly results dated Jan 31, 2021, the WMT stock has reported the following figures for:

Financial Item	Value (in USD thousands)
EBIT (from Income Statement)	-69,000
Total Assets (from Balance Sheet)	252,496,000
Total Current Liabilities (from Balance Sheet)	92,645,000
Capital Employed	= (Total Assets minus Total Current Liabilities)
	= 252,496,000 - 92,645,000
	= 159,851,000
Return on Capital Employed (ROCE)	= (EBIT / Capital Employed)
	= -69,000 / 159,851,000
	= -0.04%

In this case of WMT stock, the ROCE value is negative, which indicates that company was unable to generate earnings and ended up with losses during the given quarter. The company lost $(-0.04) for every $100 it used as its capital.

ROCE Example No. 2:
The NASDAQ-listed Amazon.com Inc (AMZN) belongs to the Consumer Services sector and is categorized under the Catalog and Specialty Distribution subsector. Amazon.com, Inc., incorporated on May 28, 1996, offers a range of products and services through its Websites. The Company operates through three segments: North America, International and Amazon Web Services ...Detailed Company Profile.
As per the quarterly results dated Dec 31, 2020, the AMZN stock has reported the following figures for:

Financial Item	Value (in USD thousands)
EBIT (from Income Statement)	8,179,000
Total Assets (from Balance Sheet)	321,195,000
Total Current Liabilities (from Balance Sheet)	126,385,000
Capital Employed	= (Total Assets minus Total Current Liabilities)
	= 321,195,000 - 126,385,000
	= 194,810,000
Return on Capital Employed (ROCE)	= (EBIT / Capital Employed)
	= 8,179,000 / 194,810,000
	= 4.2%

In this case of AMZN stock, the ROCE value is positive, which indicates that company managed to generate earnings during the given quarter. The company generated $4.2 for every $100 it used as its capital.

ROCE Example No. 3:
The NASDAQ-listed Apple Inc. (AAPL) belongs to the Technology sector and is categorized under the Computer Manufacturing subsector. Apple Inc., incorporated on January 3, 1977, designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players. The Company sells a range of related ...Detailed Company Profile.
As per the quarterly results dated Dec 26, 2020, the AAPL stock has reported the following figures for:

Financial Item	Value (in USD thousands)
EBIT (from Income Statement)	33,579,000
Total Assets (from Balance Sheet)	354,054,000
Total Current Liabilities (from Balance Sheet)	132,507,000
Capital Employed	= (Total Assets minus Total Current Liabilities)
	= 354,054,000 - 132,507,000
	= 221,547,000
Return on Capital Employed (ROCE)	= (EBIT / Capital Employed)
	= 33,579,000 / 221,547,000
	= 15.16%

In this case of AAPL stock, the ROCE value is positive, which indicates that company managed to generate earnings during the given quarter. The company generated $15.16 for every $100 it used as its capital.

Understanding and Interpretation of ROCE Value

The ROCE value calculation is essentially - How much earnings the company generated for every dollar of capital it employed?

The return on capital employed (ROCE) value indicates how much operating income or earnings got generated during the reporting period for each dollar of capital invested by the company management. A positive and higher value of ROCE is preferable, indicating that more earnings per invested dollar have been achieved.
One must note that lower, and even negative values of ROCE are possible. Negative values indicate that company has suffered net losses during the reporting period.

Comparing ROCE Values

◐ ROCE Values can be computed and compared on quarter-to-quarter or on annual basis, depending upon which financial statements are available and the time horizon being analyzed.
◐ One can compare ROCE values of the same company over the last few years or quarters. This indicates how the company has been performing in terms of utilizing the capital. However, one must note that certain industries, like agriculture, are subject to seasonality patterns hence variations may be observed.
◐ Company to company ROCE value comparison is realistic only when both companies belong to the same sector or industry.
◐ Try to derive the average industry benchmark for a particular sector, against which a company's ROCE performance can be compared against.
◐ One must ensure that same accounting period is used for making a fair comparison. Many companies follow their own custom fiscal year, and hence reported financial statements may vary by a few weeks or months.

Is ROCE better than ROE and ROA measures?

It depends!
The Return on Equity (ROE) and Return on Assets (ROA) are focused on specific categories of equity capital and assets, respectively. However, Return on Capital Employed (ROCE) calculation includes both debt and equity funding, and is assumed to be a better method to assess for the profitability efficiency of a stock.

What ROCE Range is Considered Good?

Again, it depends!
One must ensure that it is an apple-to-apple comparison while looking at ROCE values of different companies. Comparison is recommended among same sector companies, not across. Additionally, there are stocks which get impacted by seasonality patterns, like coffee growers or travel companies, and their ROCE values may vary widely across quarters. Therefore, the range of 'good' or 'bad' ROCE value is non-deterministic.

The Bottom Line

No financial ratio is perfect, and same applies to ROCE. Computing only the ROCE value may not provide the full picture of a company's efficiency and profitability. One must look for consistency across other profitability ratios such as return on assets, return on invested capital, and return on equity, in addition to using ROCE.
A few variants of ROCE formula may use NOPAT (net operating profit after tax) instead of EBIT (earnings before interest and taxes), and Capital Employed may be calculated as (Fixed Assets plus Working Capital) instead of (Total Assets less Current Liabilities).