Return on capital employed: the importance of the ratio
Before investing in any business, the investor conducts a comprehensive analysis of the company on various parameters. He evaluates key financial ratios such as return on assets. Return on capital employed (ROCE) deserves particular attention.
This ratio helps to assess the company’s profitability by providing an overview of its profitability in relation to total capital. ROCE allows the investor to gain a full understanding of the viability of the investment by assessing the business’s viability. It analyses the company’s ability to generate a return on invested capital. It also shows the percentage of profit in relation to the amount of finance.
Return on capital employed is extremely important when analysing high-cost sectors of the market. For example, ROCE is used for oil and transport companies. To calculate it, operating profit should be divided by capital employed and multiplied by 100%. This gives an approximate amount of profit for each dollar invested in the business.
If we compare ROCE with return on equity, the first ratio is more meaningful. Thanks to ROCE, it is possible to assess:
– return on funds raised;
– the debt-equity ratio.
This information will be very useful in forecasting the company’s development. For example, it will give you a rough idea of the share price for the next few years. The higher the percentage per monetary unit, the greater the company’s potential.
Features of the coefficient
ROCE is often used to compare the prospects of companies in the same market segment. For more in-depth analysis, it combines with ROIC (return on invested capital). ROIC also assesses the economic efficiency of operations by analysing the return on each dollar of investment. It also provides insight into the efficient use of funds to improve profitability.
ROIC takes into account operating profit after tax, while ROCE uses a pre-tax figure.
To calculate the return on capital employed, you need to know EBIT (earnings before interest and tax). This is profit before all deductions. Capital employed is the total capital of the business used to generate profit.
Taking into account market fluctuations and global processes, business analysis should be taken seriously. These indicators are extremely important for investment activities. Thanks to them, it is possible to assess the financial stability of the company and its prospects. After calculating EBIT, ROIC and ROCE, the investor decides on the feasibility of the investment. In addition, they can predict the percentage of profit without in-depth analysis of the business. Obviously, portfolio construction should also include other indicators. Specialists carefully study the company’s financial reports for several years, comparing the ratio of profits and losses.
