Definition, Explanation and Use of ROCE Ratio:
Return on capital employed (ROCE) ratio is used to determine the returns that a company is generating from the capital employed within the business. This ratio is used to measure the efficiency with which long term capital is being used in generating profits for the business. The ratio also helps to assess the ability of a business to generate sufficient returns for covering costs of its capital.
This ratio expresses the profit available to capital providers as a percentage of the long term capital employed within the business (regardless of whether that money has been supplied by owners or lenders). It takes into account sources of finance.
Though capital employed is normally calculated as owners’ equity plus all long term loans and preference share capital (for companies only), it may also be calculated as total assets less current liabilities or non-current assets plus net current assets.
One way of judging the adequacy of a company’s ROCE is to compare it with the return which could be expected from a risk-free investment such as bank deposit. If the company is seen as a high risk as a high risk investment, a comparatively high ROCE might be expected as compensation for this risk.
It is an important and useful measure of performance as it measures input in the form of capital employed against profit as output.
Click on Analysis of Financial Statement of a Business to read the solved example of return on capital employed ratio.