Understanding Return on Capital Employed (ROCE) or the Return on Working Capital and the Formula – Return on Capital Employed or often abbreviated as ROCE is a profitability ratio that measures how efficiently a company generates profits from working capital. In other words, this Return on Capital Employed or ROCE can show investors how much profit is generated from each Dollar invested.
Also read: Definition Of Net Profit Margin And Its Formula.
This ROCE ratio is based on two important calculations, namely operating profit ( Net Operating Profit ) and Working Capital ( Employed Capital ) used.
Net operating profit is often also referred to as EBIT ( Earning before Interest and Tax ) or Revenue before Interest and Taxes. EBIT is often reported on the Income Statement because it shows the company’s profits resulting from operations. the second component that is taken into account in the ROCE Ratio is the Employed Capital. In general, the Working Capital used in this calculation is the total assets of the company minus all of its liabilities or shareholders’ equity reduced by all of their liabilities.
How to Calculate the Return on Capital Employed (ROCE) Ratio
The following is a way to calculate the Return on Capital Employed (ROCE) Ratio along with the ROCE formula and case examples.
Formula Return on Capital Employed (ROCE) or Working Capital Returns Ratio
The ROCE Ratio formula or the Ratio of Return on Capital can be calculated by dividing net operating profit or EBIT with the Working Capital used. Below this is the ROCE Equation or Formula.
Return on Capital Employed (ROCE) = Net operating profit / Working capital
Return on Capital Employed (ROCE) = Net operating profit / (Total Assets – Liabilities)
Example of Calculation of Return on Capital Employed Ratio (ROCE) or Working Capital Returns Ratio
A company engaged in manufacturing has total assets of $ 1 billion with obligations of $ 250 million. In the same year, the company managed to obtain a net operating profit of $ 900 million. What is the Company’s ROCE Ratio?
- Net operating profit = 900,000,000, –
- Total Assets = $ 1,000,000,000 –
- Liabilities = $ 250,000,000
- ROCE =?
- ROCE = Net operating profit / (Total Assets – Liabilities)
- ROCE = 900,000,000 / (1,000,000,000 – 250,000,000)
- ROCE = 900,000,000 / 750,000,000
- ROCE = 1.2 times
So the Return on Capital Employed (ROCE) ratio for this company is 1.2 times.
Analysis and Valuation of Return on Capital Employed (ROCE) Ratio
From the above example, we can see that the ROCE calculation result of the company is 1.2 times. This means every Dollar invested in working capital will generate $ 1.2 profit or net operating profit.
The Working Capital Returns Ratio shows how much profit is made per Dollar from Working Capital. A higher ratio will be more profitable because more profit is generated by each dollar of working capital invested.