Return on Capital Employed (ROCE)

Definition

Return on capital employed (ROCE) measures how efficiently a company generates operating profit from the capital it uses. It’s a profitability metric that includes both equity and debt, making it useful for assessing capital-intensive businesses.

Formula and calculation

ROCE = EBIT / Capital Employed

Where:
* EBIT = Earnings Before Interest and Taxes (operating income)
* Capital Employed = Total assets − Current liabilities

Notes:
* Some analysts use average capital employed (opening + closing capital employed ÷ 2) to smooth timing effects.
* EBIT excludes interest and taxes so the ratio reflects operating performance before financing and tax impacts.

What ROCE tells you

• How much operating profit a company generates per dollar of capital employed.
• Whether a company uses its capital (equity + long-term debt) efficiently—higher ROCE indicates better capital productivity.
• Trends in ROCE over time signal improving or deteriorating capital efficiency; investors generally prefer stable or rising ROCE.

Advantages

• Combines profitability and capital efficiency into a single measure.
• Includes both debt and equity, useful for capital-intensive sectors (utilities, telecoms, industrials).
• Helps evaluate management’s capital-allocation decisions and compare business units or projects.

Limitations

• Not directly comparable across industries with different capital intensities.
• Backward-looking—based on historical accounting data—and may not reflect current or future prospects.
• Can be distorted by accounting choices, large cash balances, or one-time items.
• Focuses on operating returns and capital use but omits dimensions like growth, cash flow generation, or shareholder returns.

ROCE vs ROIC

• ROIC (Return on Invested Capital) = NOPAT / Invested Capital
• NOPAT = EBIT × (1 − tax rate)
• Invested capital is often calculated more precisely (e.g., net working capital + PP&E + intangibles, or debt + equity − non-operating cash).
• Key differences:
• ROIC adjusts for taxes (uses NOPAT); ROCE typically does not.
• ROIC’s invested capital definition is often narrower and more detailed than ROCE’s capital employed.
• Both should ideally exceed the company’s WACC to create value.

Example (hypothetical)

Two companies in the same industry:
* ACE Corp: ROCE ≈ 43.5%
* Sam & Co.: ROCE ≈ 15.5%

Even if Sam & Co. is larger in absolute revenue and assets, ACE Corp uses its capital more efficiently—generating more operating profit per dollar of capital employed.

How to improve ROCE

Focus on increasing operating profit and/or reducing capital employed:
* Improve operational efficiency: cut waste, automate, optimize processes to raise EBIT.
* Better capital allocation: prioritize projects with higher returns; divest underperforming assets.
* Optimize working capital: reduce inventory levels, collect receivables faster, extend payables where appropriate.
* Asset optimization: sell or repurpose underutilized assets, renegotiate leases.
* Pricing and margin management: improve product mix, raise prices where market allows.
* Monitor changes: use regular reporting to track ROCE and unintended side effects (e.g., underinvestment).

ROCE and business cycles

• Expansion: higher demand, better margins, and economies of scale can raise ROCE.
• Peak: growth may slow and ROCE can stabilize or dip as competition intensifies.
• Contraction/recession: falling sales and margin pressure typically reduce ROCE.
• Recovery: ROCE may recover unevenly—initial investments can lower ROCE temporarily, then increase if returns materialize.

Practical guidance

• Always compare ROCE among peers within the same industry.
• Consider using average capital employed for period comparisons.
• Watch for distortions from large cash balances or one-time gains/losses.
• Use ROCE alongside other metrics (ROIC, ROE, ROA, cash flow, margin and growth measures) for a fuller view.

What is a “good” ROCE?

There’s no universal cutoff, but:
* A ROCE above 20% is commonly viewed as strong.
* The key benchmark is whether ROCE exceeds the company’s WACC—sustained ROCE > WACC indicates value creation.

Bottom line

ROCE is a useful, intuitive metric for assessing how effectively a company turns capital into operating profit, especially in capital-heavy industries. Use it to compare similar companies, track trends, and evaluate management’s capital-allocation performance—but combine ROCE with other measures and qualitative analysis for robust investment or management decisions.