ROCE – Return on Capital Employed

Michael Brown

13 years ago

What is ROCE – Return on Capital Employed?

ROCE or return on capital employed measures the percentage rate of return a business gets on its capital employed. It is calculated by dividing the earnings before interest and tax by the total assets less current liabilities of the business.

Formula for Return on Capital Employed

The ROCE formula is shown below.

In the ROCE formula the terms have the following meanings.

Earnings before interest and tax (EBIT) is from the income statement. It is sometimes referred to as profit before interest and tax (PBIT).
Capital Employed is from the balance sheet and includes total assets less current liabilities.

How to Calculate the ROCE

To illustrate, the income statement and balance sheet below are used together with the ROCE formula to calculate the return on capital employed.

1. Earnings before interest and tax from the Income Statement
Revenue	440,000
Cost of sales	176,000
Gross margin	264,000
Operating expenses	135,000
EBITDA	129,000
Depreciation	65,000
Earnings before interest and tax	64,000
Interest	20,000
Income before tax	44,000
Tax	9,000
Net income	35,000

2. Capital Employed from the Balance Sheet
Cash	5,000
Accounts receivable	95,000
Inventories	50,000
Current assets	150,000
Property	390,000
Fixed assets	390,000
Total assets	540,000

Accounts payable	90,000
Other liabilities	10,000
Bank overdraft	20,000
Current liabilities	120,000
Long term debt	190,000
Total liabilities	310,000
Capital	60,000
Retained earnings	170,000
Total equity	230,000
Total liabilities and equity	540,000

In the example above, from the income statement the earnings before interest and tax is 64,000, and from the balance sheet, the total assets are 540,000, and the current liabilities are 120,000.

The ROCE formula calculates the return on capital employed as follows

ROCE = Earnings before interest and tax / (Total assets - Current liabilities)
ROCE = 64,000 / (540,000 - 120,000)
ROCE = 15.24%

The bank overdraft has been included as it is considered to be a current liability. In contrast, the bank and other loans have been assumed to be long term.

From the balance sheet above, it should be noted that the total assets less current liabilities is equal to the equity plus long term liabilities, so that ROCE can also be defined as follows:

ROCE = Earnings before interest and tax / (Equity + Long term liabilities)

Return on Capital Employed Interpretation

The ROCE is considered to be a fundamental financial ratio for a business. It measures the ability of a business to use its money to generate earnings. Interest is specifically excluded from the calculation by the use of earnings before interest and tax as the amount of interest paid depends on the amount of debt and therefore the capital injected by the owners. If interest was included it would distort the ROCE calculation and make it impossible to make comparisons with another business funded in a different manner.

Useful tips for Using the ROCE

The ROCE (return on capital employed) will vary from industry to industry. Therefore to make comparisons you need to use a comparable business operating in your sector.
The return on capital employed will need to be higher than the return available if the same amount of money was invested in a minimal risk deposit with a bank.
ROCE should always be higher than the rate at which the business borrows as an increase in borrowing leads to an increase in assets which in turn should give a higher return if the ROCE is at the correct level.

Last modified May 26th, 2023 by Michael Brown

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.