Return on Capital Employed (ROCE) –
Return On Capital Employed is a profitability ratio which tells us that how company use its capital to make profits. Investors and Analysts use this ratio to find potential investments options. This is very important ratio and everyone should use this ratio for investments.
Return on capital employed is calculated by dividing EBIT by Capital Employed. EBIT is nothing but Earning Before Interest and Taxes, some people use Net Profit instead of EBIT. Capital Employed is calculated by substracting Current Liabilities from Total Assets. There is another way also to calculate Capital Employed and that is Non-Current Assets adding with Working Capital. Non-Current assets are mentioned in balance sheet and working capital can be calculated by substracting Current Liabilities from Current Assets.
EBIT = Earning Before Interest and Taxes
Capital Employed = Total Assets – Current Liabilities
Capital Employed = Non-Current Assets + Working Capital
Working Capital = Current Assets – Current Liabilities
Lets take examples,
Above examples shows information about company A and Company B, EBIT of company A is 50 and EBIT of company B is 35. We have calculated capital employed using both formulas and that is capital employed of company A is 175 and company B is 145. So from above calculations we have calculated ROCE of company A is 29% and company B is 24%. ROCE shows that company A is more profitable than company B which means company A is using its capital efficiently as compare to company B.
ROE and ROCE should be very close to each other. There should not be the major gap between these both ratios.
ROCE shows business performance and ROE shows investments performance.