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Return on Capital Employed Ratio (ROCE)

Return on Capital Employed Ratio Assignment / Homework Help
ROCE is the most important ratio of all. It is the percentage of return on total capital employed in the business. The term total capital employed refers to long term funds supplied or invested by the creditors and owners of the company. Consequently, capital employed is the total of non-current liabilities (long term liabilities) and owner's equity. In short, this ratio tells the owner whether or not all the efforts put into the business has been worthwhile. The ROCE is calculated as follows:

          EBIT          
Capital Employed

Where:
EBIT is Earnings before Interest and Taxes

Capital Employed = Long term liabilities + Owner’s equity OR Total assets – Current liabilities

Generally, average of opening and closing capital employed is considered for computing this ratio in which case it is also referred to as Return on Average Capital Employed. The profitability of the firm related to the sources of long-term funds can be judged from this ratio. One must compare this ratio with the ratio of similar firms, with the industry average and over a period of time to get meaningful insight into how efficiently the long term funds of owners and creditors are being used. The higher the ratio, the more efficient is the use of capital employed. The ratio must always be higher than the firm's cost of borrowings to be accretive to the shareholders.

One of the drawbacks of ROCE is that it is computed on the book values as reflected in the financial statements. Over time, the book value of assets reduces boosting the ROCE ratio. This may not be correlated with the cash flows generated from the company and may be misleading.

Example:

A company having an EBIT of $245,654 and total assets of $2,345,525 and current liabilities of $786,245 would have a ROCE of:

            $245,654            
($2,345,525 - $786,245)

=> 15.75%


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