How To Calculate Return on Capital Employed (ROCE)?
Return on capital employed is a profitability ratio. By using this ratio, you can measure your business’s efficiency of earning profits by utilising the capital employed (Also see Understanding Payback Period). This ratio may be helpful to you in terms of showing how much profit can each dollar of the capital employed generate. The return on the capital employed ratio is a long-term profitability ratio because it tells the efficiency of the performance of assets in a certain period. Hence, you can see from here that this ratio considers the long-term financing of the company. Also, this ratio is among the crucial financial ratios that professional investors would use when they assess the investments.
If you want to calculate the return on capital employed, you need to compare the capital employed and the net operating profit.
Firstly, you should calculate the company’s net operating profit. Some people would call it the earnings before interest and taxes. Most companies will usually show this figure in their profit and loss statement. If not, you may add up the interests and taxes before adding this amount to the net income of that company.
Then, you should calculate the sum of the capital employed. Keep in mind that you may see the term ‘capital employed’ being used in referring to a wide range of different financial ratios. Nevertheless, in this situation, this term refers to the total assets of the company less the sum of liabilities related to that business.
Lastly, to calculate the return on capital employed, you should divide the net operating profit by the capital employed you have calculated.
If you want to know the accurate return of capital employed of your company, you probably have to modify the figures you have calculated in the steps mentioned above. You need to do this as your company may have some cash available to be used (Also see Understanding Cash Collection Cycle). As you do not employ the cash actively in your business, you need to minus it from the amount of capital employed.
Analysing the ROCE
If the value of ROCE of your company is high, it indicates that your company is using the capital (Also see How Can Startups Raise Their Capital) it has efficiently. On the other hand, a lower value of ROCE implies that your company is not using its capital effectively, and it is unable to meet the expectation of its shareholders in terms of generating the shareholder value.
You may use the return on capital employed to forecast your company’s future as it acts as a measure of profitability. This can be done by comparing the value of this ratio with the previous year’s figure.
Apart from that, a majority of the investors will assess the return on capital employed of your company before they make their investment decision. Thus, you need to make sure that you have calculated this ratio correctly. If you are not familiar with accounting, you may consider hiring an internal accountant. Otherwise, you may employ an accounting firm in Johor Bahru and let the experts complete the task for you.