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Capital employed is a fairly convoluted term because it can be used to refer to many different financial ratios. Most often capital employed refers to the total assets of a company less all current liabilities. Both equal the same figure. Return on capital employed formula is calculated by dividing net operating profit or EBIT by the employed capital.
In this case the ROCE formula would look like this:. The return on capital employed ratio shows how much profit each dollar of employed capital generates. Obviously, a higher ratio would be more favorable because it means that more dollars of profits are generated by each dollar of capital employed. For instance, a return of. Investors are interested in the ratio to see how efficiently a company uses its capital employed as well as its long-term financing strategies.
If companies borrow at 10 percent and can only achieve a return of 5 percent, they are loosing money. In other words, a company that has a small dollar amount of assets but a large amount of profits will have a higher return than a company with twice as many assets and the same profits. There are two components required to calculate return on capital employed: earnings before interest and tax and capital employed. EBIT , also known as operating income, shows how much a company earns from its operations alone without regard to interest or taxes.
EBIT is calculated by subtracting the cost of goods sold and operating expenses from revenues. ROCE can be especially useful when comparing the performance of companies in capital-intensive sectors, such as utilities and telecoms.
This can help neutralize financial performance analysis for companies with significant debt. Thus, a higher ROCE indicates stronger profitability across company comparisons. For a company, the ROCE trend over the years can also be an important indicator of performance. The table below shows a hypothetical ROCE analysis of both companies. Both metrics are similar in that they provide a measure of profitability per total capital of the firm. The calculation for ROIC is as follows:. Invested capital may be either:.
Financial Ratios. Tools for Fundamental Analysis. Your Money. Personal Finance. Your Practice.