Financial modelling terms explained

Return On Capital Employed

ROACE, also known as return on capital employed, is an important profitability ratio that measures how much profit a company makes on the capital it has invested into its business. The ratio is calculated by dividing the net income by the average amount of capital invested.

What is Return on Capital Employed?

Return on capital employed (ROCE) is a measure of a company's profitability that takes into account the amount of capital invested in the business. ROCE is calculated by dividing a company's operating profit by its capital employed. Operating profit is calculated by subtracting the company's operating expenses from its revenue. Capital employed is calculated by adding the company's long-term debt and shareholders' equity.

ROCE is a key measure of profitability for companies and is used to assess how efficiently a company is using its capital to generate profits. A high ROCE indicates that a company is using its capital effectively and is generating a high return on the investment. A low ROCE indicates that a company is not using its capital efficiently and is not generating a high return on the investment.

ROCE can be used to compare the profitability of companies in different industries or to compare the profitability of companies over time. It can also be used to assess the value of a company. A high ROCE indicates that a company is generating a high return on the investment and is likely to be a good investment. A low ROCE indicates that a company is not generating a high return on the investment and is likely to be a not a good investment.

How Do You Calculate Return On Capital Employed?

There are a few different formulas that can be used to calculate return on capital employed (ROCE), but the most common is:

ROCE = Net Income / Capital Employed

This formula takes into account both the company's income and the amount of capital it has invested in assets. To calculate ROCE, you need to know the company's net income (profit) and its capital employed. Capital employed is made up of two components: shareholders' equity and debt.

Shareholders' equity is the total amount of money that shareholders have invested in the company. Debt is the total amount of money that the company has borrowed from banks or other lenders. To calculate capital employed, simply add up shareholders' equity and debt.

Once you have calculated capital employed, you can calculate ROCE by dividing net income by capital employed. This will give you a percentage that tells you how efficient the company is at using its capital to generate profits.

Who Uses Return on Capital Employed?

There is no single answer to this question as different entities will use return on capital employed (ROCE) in different ways. In general, ROCE can be used by businesses to measure how efficiently they are using their capital to generate profits. This can be helpful in assessing how well a company is performing compared to its competitors, and can also be used to inform decisions about how to allocate resources. Investors may also use ROCE as a measure of a company's profitability when making decisions about whether to invest in that company.

What Do You Have to Watch out for When You're Calculating Return on Capital Employed?

There are a few things to watch out for when calculating return on capital employed (ROCE), including:

1. Making sure you're using the same definition of ROCE for all companies in the comparison.

2. Including all capital employed in the calculation, including short-term debt and current liabilities.

3. Not including one-time items or exceptional items in the calculation.

4. Making sure the time period you're using is the same for all companies in the comparison.

5. Correctly calculating the earnings before interest and taxes (EBIT) figure.

6. Correctly calculating the capital employed figure.

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