Return on Capital Employed (ROCE)
ROCE examines how efficiently any company can use the available capital with the help of this equation:
ROCE = EBIT/Capital Employed
where: EBIT = Earnings before interest and taxes and Capital Employed = Total assets minus current liabilities
​Capital employed is defined as the total amount of a firm’s assets minus its current liabilities. It is synonymous with the available capital from the net profits. The higher the value that is derived using the ROCE formula, the more efficiently a company is utilising their capital. It is important to understand that the ROCE is exceeding the cost of capital, or the company may end up facing financial issues. It can be very useful to compare the use of capital by different companies that are engaged in the same business with regard to capital intensive industries like auto companies, energy companies and telecommunications firms.
Return on Investment (ROI)
ROI is defined as a popular profit metric that is used to evaluate the company’s investments and its financial consequences with respect to the overall cash flow. The formula for ROI is as follows:
ROI = Profit from Investment/Cost of Investment ×100
Any value of ROI that is greater than zero is a reflection of the net profitability. The higher values are an indication of the effective use of capital investment. A negative value is considered as a major warning signal of extremely poor capital management.
ROI can be utilised by the companies internally for the purpose of evaluating the profitability of production of a product versus another to determine which product’s distribution and manufacturing represent an efficient use of the company’s capital.
Difference between ROCE and ROI
Return on Capital Employed (ROCE) and Return on Invested Capital (ROI) are both profitability ratios that can help to give you a better idea of the financial soundness of a company. However, there are many areas of difference between ROCE and ROI, which we should discuss below to get a better insight into this topic:
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Return on Capital Employed (ROCE) is a financial metric that helps to determine how efficient a company is in terms of generating revenue with the capital in hand. |
Return on Investment (ROI) is a financial metric that helps to measure how well a company can generate revenue using the invested capital. |
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The formula for Return on capital employed is as follows: ROCE = EBIT / Capital Employed where: EBIT = Earnings before interest and taxes and Capital Employed = Total assets minus current liabilities |
The formula of Return on investment is as follows: ROI = Profit from Investment / Cost of Investment ×100 |
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ROCE considered the operating income of a company, i.e. earnings before interest and tax (EBIT). |
Return on investment considers the overall net profit, which remains after the payment of taxes and dividends. |
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Return on capital employed has a much broader scope than ROI, as it considers all the capital employed in a company. |
Return on investment has a much narrower and refined scope than Return on capital employed, as it only considers the invested capital of a company. |
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Return on capital employed helps to take a look at the financial situation of the organisation and is useful for further analysis from the company’s perspective. |
Return on investment helps to take a look at an organisation’s financial situation from the perspective of an investor. It also helps investors to get a better idea of the prospective returns, which they can get on the invested capital. |
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Return on capital employed is a good indicator of a company’s ability to generate revenue. |
Return on investment is a good indicator of a company’s productivity in terms of its operating assets. |
Conclusion
Given all this, both ROCE and ROI are two important profitability ratios that are similar to each other in spite of minor differences. It is also important to note these ratios hold good for companies with capital intensive business operations like manufacturing entities. The scope of ROCE and ROI is quite limited with respect to service-based companies.
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