Return on Capital Employed Calculator (ROCE)

The return on capital employed calculator determines how profitable a company uses its financing to generate operating income. This ratio is much more precise than ROE (return on equity) because it includes both financing sources: equity and interest-bearing debt – see the cost of equity calculator and debt to income ratio calculator.

In this calculator, we will explain what return on capital employed (ROCE) is and discuss its importance, explain how to calculate the return on capital employed (two approaches for the ROCE formula), and finally, what is a good value of ROCE.

The return on capital employed (ROCE) is a ratio that measures how much operating profit a company makes from its capital employed.

When mentioning capital employed, we have to remember the two main ways of financing a business: by acquiring debt and by selling pieces of the ownership of the company (selling shares).

Thus, the capital employed considers equity and liabilities. However, we do not consider all liabilities, such as accounts payable. We specifically consider interest-bearing debt, and we only account for long-term debt because we are talking about long-term financing.

Because companies might have long-term leases, we prefer to use the non-current liabilities account in order not to miss any long-term interest-bearing liability.

Because of the main accounting equation:

Assets - Liabilities = Equity

where:

Liabilities = Current liabilities - Non current liabilities

The capital employed is defined as:

Capital employed = Equity + Non-current liabilities,

The capital employed can also be expressed as:

Capital employed = Total assets - Total current liabilities

Hence, there are two return on capital employed formulas:

1. ROCE = EBIT / (Total assets - Total current liabilities)

2. ROCE = EBIT / (Equity + Non current liabilities)

Besides, EBIT stands for earnings before interests and taxes and is considered as the operating earnings considering the depreciation of the tangible assets used in operations and the amortization of the non-tangible assets.

For a more precise income generated by operations that are not affected by non-cash expenses, please consider EBITDA.

There are three simple steps you need to calculate ROCE by hand. Of course, you can get the data and input it into our great return on the capital employed calculator to get the result even faster.

1. First, get EBIT. You can work backward the value of EBIT by using net income and adding back tax provisions and interest expense, or you can take the operating income from the income statement.

2. From the balance sheet, take the total assets and the Total current liabilities or the Equity and the Non-current liabilities.

3. Use the ROCE formula specified above or input the values in our fancy return on the capital employed calculator. The result is expressed as a percentage.

We are going to analyze a company that has returned 191% in capital gains in the last 12 months (see capital gains yield calculator). Its name is Synnex, a TI (technical information) company related to the data center business.

Since this ratio is helpful for finding businesses that are efficiently using their capital employed and is very likely to lead to good capital returns investments, we will find out the ROCE of the company considering the last quarter, one year ago.

In that case, we have the Synnex first quarter 2020 report, which will be the last of the four quarters we are going to include for calculating the EBIT.

From the report, we get:

EBIT_{Q1 20} = 188,655 thousands USD

Total assets = 11,727,054 thousands USD

Total current liabilities = 4,227,152 thousands USD,

then:

Capital employed = 7,499,902 thousands USD

Now, we only need the 4th quarter report 2019, 3rd quarter report 2019, and the 2nd quarter report.

We get:

EBIT_{Q4 19} = 268,288 thousands USD

EBIT_{Q3 19} = 208,855 thousands USD

EBIT_{Q2 19} = 174,655 thousands USD

Consequently, the last twelve month (LTM) EBIT from 1 year ago (August 2020) will be:

EBIT_{LTM Aug. 20} = 188,655 + 268,288 + 208,855 + 174,655 thousands USD

EBIT_{LTM Aug. 20} = 840,453 thousands USD

Finally:

ROCE_{LTM Aug. 20} = 840,453/ 7,499,902 = 11.21%

The return on capital employed for the last reported twelve months by August last year (2020) is 11.21%.

Furthermore, we are going to calculate the previous last twelve months by using the other formula. Hence we need the following:

EBIT_{LTM Aug. 19} = 675 million USD

Equity = 3510.4 million USD

Non-current liabilities = 3370.4 million USD

Then:

Capital employed_{LTM Aug. 19} = 3510.4 + 3370.4 = 6880.8 million USD

ROCE_{LTM Aug. 19} = 675 / 6880.8 = 9.81%

Note how the return on capital employed increased by 40 basis points over a year.

As mentioned above, ROCE is one of the few ratios that considers both ways of company financing: equity and interest-bearing debt. As a side note, there is another similar ratio: the return of invested capital (ROIC) – see the ROIC calculator.

Such ratios are essential because they include the influence of debt on the performance/profitability of the company. Otherwise, you can be biased with ratios such as ROE that only considers equity and not the effect of long-term liabilities.

A good ROCE is only good when it is above its weighted average cost of capital (WACC). This is because the WACC represents the cost of acquiring debt and equity. Consequently, companies must get a return (ROCE) larger than the cost of the capital.

Usually, a ROCE above 15% reflects an outstanding stock. However, it depends on the industry to which the company belongs. The average ROCE of a cybersecurity company is not the same as the average ROCE of a steel mill company. Of course, the second one is much more capital intensive (more capital employed) and will have more depreciation in their assets (less EBIT). Thus, the average ROCE will be lower.

Finally, the trend is as important as the ROCE value itself. We want companies that sustain a positive and growing ROCE over the years.

As always in stock picking, a good ROCE must be used along with the interest coverage ratio and revenue growth analysis.

The return on capital employed is a metric that indicates how many operating profits a company makes compared to the capital employed.

The capital employed refers to capital provided to the company by banks and by investors. Hence, capital employed is calculated by adding the non-current liabilities to the equity.

Finally, to find ROCE, we have to divide the operating income by the capital employed. EBIT can represent the operating income.

An acceptable return on capital employed is only good when it is above its weighted average cost of capital (WACC). This is because the WACC represents the cost of acquiring debt and equity.

Consequently, companies must get a return (ROCE) larger than the cost of the capital. Typically, a company with a ROCE above 15% is a good stock pick; however, it will always depend on the industry to which the company you review belongs. Each industry has its average ROCE. The idea is that your company's ROCE is above such average.

To calculate the return on capital employed:

1. First, get the EBIT. Take the net income and add back tax provisions and interest expense (both in the income statement), or you can directly take the operating income.

2. From the balance sheet, take either the total assets and the total current liabilities or the equity and the non-current liabilities.

3. Put the values in the respective field of Omni's excellent ROCE calculator. If you want to do it yourself, follow the next steps.

4. Calculate capital employed. One method is to subtract total assets minus total current liabilities. The other method is to add non-current liabilities to the value of equity.

5. Divide EBIT by capital employed and multiply it by 100% to express it as a percentage.

We calculate return on equity (ROE) by dividing net income by equity; meanwhile, return on capital employed (ROCE) is calculated by dividing EBIT (earnings before interests and taxes) by capital employed. Hence, starting from that, we see the following two main differences:

1. ROE can be affected by the size of liabilities. Remember, assets minus liabilities results in equity. Hence, you might have a high ROE because of a highly leveraged company. That's not advisable. On the other hand, ROCE directly includes the effect of long-term debt on the capital employed.

2. ROE compares net income, which is affected by financial expenses and taxes expenses; meanwhile, ROCE uses EBIT, which is more related to the operating income. Consequently, ROE measures shareholder profitability, and ROCE indicates operations profitability.