ROCE Calculator

What this ROCE calculator does

Profit on its own tells you almost nothing. A business earning 180,000 a year is doing brilliantly if it needed 900,000 of capital to do it and rather badly if it needed nine million.

Return on capital employed answers that. It divides operating profit by the long term capital the business is actually using, and gives you a percentage you can compare against other companies, other years, and the cost of the money funding it.

Give this calculator your EBIT, your total assets and your current liabilities, and it works out capital employed and returns ROCE.

It is the ratio most professional investors reach for first when judging operating quality, because unlike margin it cannot be flattered by a business that simply happens to sell expensive things, and unlike return on equity it cannot be inflated by borrowing.

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How to use it

1. EBIT. Earnings before interest and tax, also called operating profit. Take it from the income statement, above the interest line. Using net profit instead will understate ROCE, sometimes badly.
2. Total Assets. The balance sheet total.
3. Current Liabilities. Everything due within a year: trade payables, short term borrowings, accruals, the current portion of long term debt.

Press Calculate. Press Reset to clear it.

Use figures from the same balance sheet date and the same accounting period throughout. Mixing a full year of profit with a half year balance sheet produces a number that means nothing.

One thing the tool will not currently accept is a negative or zero EBIT, so a loss making year cannot be measured here. A negative ROCE is a perfectly meaningful result and is exactly what you would want during a downturn, so this is on our list. In the meantime the arithmetic is one division and the formula is below.

The formula, and what capital employed means

ROCE = EBIT ÷ capital employed × 100

Where:

Capital employed = total assets − current liabilities

That subtraction is the whole idea, and it is worth understanding rather than accepting.

A business is funded from two directions. Some of the money is long term: shareholders' equity and long term borrowing, both of which somebody expects a return on. Some of it is short term and effectively free: your suppliers letting you pay in sixty days, wages accrued but not yet paid, tax owed but not yet due. Nobody charges you for that funding.

Capital employed strips out the free money and leaves the capital that actually costs something. Which means ROCE measures the return on money the business had to pay for, and that is the return worth judging management on.

There is a second route to the same figure that you will see in textbooks: equity plus non-current liabilities. It comes out identical, because a balance sheet balances, and it is sometimes easier to pull straight off published accounts.

A worked example

A company with EBIT of 180,000, total assets of 1,200,000, and current liabilities of 300,000.

Capital employed: 1,200,000 − 300,000 = 900,000

ROCE: 180,000 ÷ 900,000 = 20.00 percent

So every unit of long term capital in this business generates twenty units of operating profit per hundred, each year.

Notice the effect of that 300,000 of current liabilities. Had we divided by total assets instead, the answer would have been 15 percent. The supplier credit and accruals are doing real work in this business, funding a quarter of its assets at no cost, and ROCE gives management credit for that where return on assets would not.

Every ROCE is a margin times a turnover

This is the most useful thing to know about the ratio, and it comes from a piece of algebra so simple it looks like a trick.

ROCE = ROS × (sales ÷ capital employed)

It works because the sales cancel: (EBIT ÷ sales) × (sales ÷ capital employed) = EBIT ÷ capital employed.

So ROCE always breaks into two things a business can control separately. How much profit it makes on each sale, which is its return on sales. And how many times it turns its capital over in sales each year.

Two businesses with identical ROCE can arrive there by opposite routes:

The supermarket makes three pence on every pound and sells its capital base nearly seven times a year. The luxury brand makes thirty pence on every pound and turns over two thirds of its capital. Both earn 20 percent, and they are completely different businesses.

That is why comparing margins across industries is close to meaningless while comparing ROCE is not. It is also a practical diagnostic: if your ROCE is falling, this decomposition tells you immediately whether the problem is pricing and cost control, or whether the business has become bloated with capital that is not producing sales.

The definition you choose changes the answer

ROCE is not defined in any accounting standard, which means published figures use slightly different bases and the differences are not small.

Here is the same company at the same EBIT of 180,000, varying only how much sits in current liabilities:

The same company looks 71 percent more profitable at the bottom of that table than at the top.

Other choices people make, all defensible and all producing different numbers. Some use the average of opening and closing capital employed rather than the closing figure, which is more accurate for a business that grew during the year. Some deduct cash on the grounds that idle cash is not employed in the business, which raises ROCE for cash rich companies considerably. Some use EBIT after adjusting for one off items.

None of that is a problem as long as you are consistent. It becomes a problem the moment you compare your carefully calculated figure against a number you found somewhere else without checking how it was built.

So the rule: if you are comparing two companies, calculate both yourself from their published accounts using the same definition. If you are tracking one company over time, use the same method every year and never change it midway.

Reading the number, and the one comparison that matters

Broadly, and with the caveat that industry matters enormously:

But the band that actually matters is the first row, and it deserves stating on its own.

Compare ROCE against the cost of capital. A business earning 8 percent on capital that costs it 10 percent is losing value every year it operates, even while reporting a profit. A business earning 20 percent on capital costing 9 percent is creating value at a rate of eleven points a year on everything it employs. That gap, sometimes called the economic spread, is the single most informative thing you can calculate about a company's operating quality.

Our WACC calculator gives you the other side of that comparison.

Two further habits worth having. Look at several years, because one year's ROCE can be distorted by an acquisition, a disposal, or an unusually good or bad trading period. And look at the trend alongside the level, since a business at 18 percent and falling is telling a different story from one at 14 percent and climbing.

Where to find industry figures

Because ROCE varies so much by sector, a number is only useful against a comparable one. Two sources worth knowing.

Aswath Damodaran at NYU Stern publishes return on capital and operating margin by industry, free, updated in the first weeks of each January and archived for previous years. It covers the US in detail and has regional breakdowns including Europe, Japan, China and India. For anyone doing this work seriously it is the most useful free dataset available, and it is what we would point you to over any commercial screener.

The other source is the companies themselves. Pull the accounts of three or four direct competitors, calculate ROCE for each on your own consistent definition, and you have a benchmark that is more relevant than any industry average, because industry categories are broad and your actual competitors are not.

One caution about published averages generally. They are usually means across a sector that may contain very different business models, and a handful of very large or very unprofitable companies can pull them around. Treat them as orientation rather than as a target.

Questions people ask

How do I calculate ROCE?

Divide EBIT by capital employed, where capital employed is total assets minus current liabilities. Multiply by 100 for a percentage.

What is a good ROCE?

Above your cost of capital, first and foremost. Beyond that it depends on the industry: 15 to 20 percent sustained is solid in most sectors, and capital intensive businesses run lower.

Should I use EBIT or net profit?

EBIT. Capital employed includes debt funding, so the profit figure needs to be before the interest paid on that debt. Using net profit mixes the two and understates the return.

How is ROCE different from return on equity?

ROE measures return to shareholders only and rises with borrowing. ROCE measures return on all long term capital and does not, which makes it the better measure of operating quality and the harder one to flatter.

And from return on assets?

Return on assets divides by the whole balance sheet including short term liabilities. ROCE excludes those on the grounds that supplier credit is free funding rather than capital employed.

Can ROCE be negative?

Yes, when EBIT is negative, and it is a meaningful figure. The calculator does not currently accept it, so for a loss year do the division by hand.

Should I use opening, closing or average capital employed?

Average is more accurate for a business that grew during the year. Closing is simpler and more common. Either is fine as long as you use the same one consistently.

References

A note on sourcing. Return on capital employed is not defined by any accounting standard, so published figures vary in their treatment of cash, averaging and one off items. The industry return on capital and margin datasets referenced below are compiled by Aswath Damodaran at NYU Stern, updated annually in January and archived for prior years, and are the most widely used free benchmark source for this kind of comparison.

1. Damodaran, A., Return on Capital by Sector, United States, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/roc.html
2. Damodaran, A., Margins and ROIC by Sector, United States, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/mgnroc.html
3. Damodaran, A., Useful Data Sets, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html
4. Damodaran, A., Cost of Capital Central, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/wacccentral.html