Return on capital employed (ROCE) is one of profitability indicators and it indicates how efficiently the company manages its long-term resources, i.e. how much profit will be generated by the unit of the long-term investment.
As the result, ROCE provides better information than ROE, because ROE has in the denominator only equity and as such does not consider the amount of loans (i.e. long-term liabilities).
* can be in the form of average of the start and end of the period
Profit in the numerator is mostly EBIT, but can be also EBT, EAT, Net income or Net income less the interest on long-term loans.
Comparisons and recommended values
- general comparatives in the financial analysis
- current cost of borrowing (i.e. mainly interest rate), which should not exceed ROCE. There is no fixed recommended value, but it should be at least 2 times higher ROCE. (10)
- with the corporate WACC, which ROCE should exceed
Disadvantages of ROCE
- problems with comparability as different categories of profit form the numerator
- capital-intensive companies reaching the same profit as companies with less need for capital will have lower ROCE; comparison of companies in different industries can thus be inconsistent
- indicator is dependent on the valuation of assets - e.g. overstatement of fixed assets leads to a decline in ROCE for two reasons:
- overvaluation of assets (higher denominator = lower ROCE)
- overstatement of depreciation = decrease of profit (lower numerator = lower ROCE)