Return on capital employed
Investment appraisal and performance measurement.
An accounting measure of management performance, calculated as the accounting profits divided by the total book value of the capital employed to earn the profits.
This measure needs care in its definition and application, because both the 'profit' and the 'capital employed' inputs can be defined in different ways.
For example, depending on the context, the 'profit' may be either before tax or after tax.
Similarly, whilst 'capital employed' will always include an appropriate measure for debt, the measure of debt which is considered appropriate may differ, according to the context.
- Simple accounting before-tax ROCE based on operating profit and non-current liabilities
- In the absence of other more detailed information, a very simple before-tax measure of ROCE is:
- ROCE = Operating profit / (equity + non-current liabilities)
- In this very simple accounting context:
- 'Operating profit' is the before-tax profit measure, often the same as profit before interest and tax (PBIT); and
- 'Non-current liabilities' are the relevant measure of debt.
- (It is assumed here - in the absence of any other information - that all non-current liabilities are debt.)
- Refining the measure of capital employed in the treasury context
- In treasury and other more advanced contexts, the measure of debt may be refined in a number of ways.
- This reflects the treasury perspective that sufficient operating returns must be earned to service the capital providers.
- For example:
- Any non-current liabilities which are identified and which are not debt are excluded from the measure of capital employed.
- Debt may be defined as net debt, in other words taking account both of shorter-term debt and of the netting off of most cash and cash-equivalent surpluses.
- After-tax ROCE for EVA calculations
- When ROCE is used in the calculation of economic value added (EVA), its inputs are defined as:
- Return = PBIT x (1 - Tax rate)
- Capital Employed = Book value of Equity + Book value of Debt.