Return on Capital Employed (ROCE)
is a measuring tool that measures the efficiency and profitability
of capital investments undertaken by a corporation. A
firm acquires capital assets such as trucks, computers,
etc to help makes its business operations more efficient,
cut down on costs and realize greater profits or acquire
more market share.
Return on Capital Employed ratio
also indicates whether the company is earning sufficient
revenues and profits in order to make the best use of
its capital assets. It is expressed in the form of a percentage,
and the higher the percentage, the better.
The formula for Return on
Capital Employed (ROCE) is:
Earnings
Before Interest & Taxes
Total
Assets - Current Liabilities
or
Operating
Profit
Shareholder's
Equity
How Can Firms Increase the Return
on Capital Employed Ratio?
Firms can increase their Return on
Capital Employed Ratio by:
Cutting costs so
as to increase the Profit Margin ratio
Buying raw material and other goods
at cheaper costs
Limitations of Using Return on Capital
Employed Ratio
Be careful when using the Return on
Capital Employed ratio because it does not always yield
the correct percentage. For instance, take a company that
cuts down on its capital investments so as to increase the
Return on Capital Employed ratio. This means the denominator
"Total Assets - Current Liabilities" will be higher,
because "Total Assets" will be lower (because
of lesser capital assets).
In this case, there has been no improvement
in operations of the company, infact the firm is cutting
down on potentially profitable capital investments! This
is one of the major limitations of using the Return on Capital
Employed ratio.
