Return on Average Capital Employed (ROACE)

Return on Average Capital Employed (ROACE)

What is ROACE?

Return on Average Capital Employed (ROACE) measures how efficiently a company generates operating profit from the capital it has invested over a period. Unlike single-point measures, ROACE uses average capital across the period, which smooths seasonal or timing effects and gives a clearer view of capital efficiency—particularly useful for capital-intensive industries (e.g., oil, utilities, manufacturing).

Formula and components

ROACE = EBIT / Average Capital Employed

Where:
* EBIT = Earnings Before Interest and Taxes (operating profit)
* Average Capital Employed = (Capital Employed at beginning of period + Capital Employed at end of period) / 2
* Capital Employed = Total Assets − Current Liabilities

You can also compute average capital employed by averaging total assets and average current liabilities separately and subtracting, but the result should represent the average funds tied up in the business over the period.

How to calculate (step-by-step)

1. Calculate EBIT: EBIT = Revenue − Operating expenses (exclude interest and tax).
2. Compute capital employed at the start and end of the period:
3. Capital employed = Total assets − Current liabilities
4. Average those two capital-employed figures:
5. Average Capital Employed = (Beginning capital employed + Ending capital employed) / 2
6. Divide EBIT by the Average Capital Employed and express as a percentage:
7. ROACE = EBIT / Average Capital Employed

Practical example

Assume:
* Beginning assets = $500,000; beginning current liabilities = $200,000
* Ending assets = $550,000; ending current liabilities = $200,000
* Revenue = $150,000; Operating expenses = $90,000

Steps:
1. EBIT = $150,000 − $90,000 = $60,000
2. Capital employed (beginning) = $500,000 − $200,000 = $300,000
3. Capital employed (end) = $550,000 − $200,000 = $350,000
4. Average Capital Employed = ($300,000 + $350,000) / 2 = $325,000
5. ROACE = $60,000 / $325,000 = 0.1846 → 18.46%

ROACE vs ROCE

ROCE (Return on Capital Employed) is similar but typically uses capital employed at a single point in time:
* ROCE = EBIT / Capital Employed (single period figure)

Key difference: ROACE averages capital across a period, reducing distortion from seasonal swings or one-off asset changes. ROCE is simpler but can be skewed by timing.

Limitations and caveats

• Depreciation effect: As assets depreciate, capital employed can shrink and ROACE can rise even if operating performance is flat—this can obscure the need for reinvestment.
• Accounting differences: Variations in asset valuation, depreciation policies, and classification of liabilities affect comparability across companies.
• Capital structure: Because EBIT excludes interest, ROACE focuses on operating efficiency and ignores financing decisions; compare with metrics that capture leverage when needed.
• One-period average: Using only beginning and ending balances may still miss intra-period volatility; multi-period averaging can improve accuracy.

How investors and analysts use ROACE

• Compare operational efficiency across peers in capital-intensive sectors.
• Assess whether a company is generating returns above its cost of capital (ROACE > WACC suggests value creation).
• Track trends over time to see if capital investments are becoming more or less productive.
• Complement with other ratios (ROE, ROIC, ROCE, margin analysis) for a fuller picture.

Key takeaways

• ROACE shows how well a company turns invested capital into operating profit, using average capital to smooth timing effects.
• A higher ROACE generally indicates more efficient use of capital, but beware of distortions from depreciation and accounting policies.
• Use ROACE alongside cost-of-capital measures and other performance metrics to judge corporate performance and investment quality.