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Fundamental analysis allows you to assess whether or not a company's financial stability and financial soundness are good. This allows you to make investment decisions based upon whether or not the company is fundamentally sound. One of the most common ways to analyze and calculate profitability ratios in companies is by using spreadsheets.
The Return on Capital Employed and Return on Invested capital (ROIC), are two profitability ratios that give an indication of the financial strength of companies. This article will explain the differences between these ratios.
The ROCE (Return on Capital Employed) financial metric helps you assess how efficient a company can be in generating revenue from the capital it has. High ROCE is always positive as it means that the company generates revenue and profits with its capital.
The following formula will allow you to calculate the Return On Capital Employed of a company.
| ROCE = Earnings before Interest and Tax (EBIT)/Capital Employed |
Where?
Capital employed = Shareholder equity + long-term debt obligations
(or)
Capital employed = total assets - current liabilities
Another financial metric is the Return on Invested Capital. It measures how well a company generates revenues from its capital. This allows investors to calculate the potential returns they will earn from their investment in a company. A high ROIC figure, similar to ROCE, indicates that a company generates revenue efficiently using funds invested by its investors.
Here's how to calculate the Return On Invested Capital of a company:
| ROIC = Profit after Tax / Invested Capital |
Where?
Invested capital = Fixed assets + Intangible Assets + Current Assets - Current Liabilities - Cash
Let's now look at the differences between ROCE and ROIC.
| Particulars | Return on Capital Employed ROCE | Return on Invested Capital ( ROC ). |
| Taken into account Metrics | ROCE takes into account the company's operating income, I.E. Earnings before Interest and Tax (EBIT). | ROIC takes into account the company's overall net profit after all taxes and dividends. |
| Portion Of Capital Considered | The Return on Capital Employed is the sum of all capital that a company uses in its business.
This includes Shareholders' Equity and other long-term debt obligations such as loans or borrowings that a company would have taken to further its business. ROCE also considers capital used by the company for activities other than revenue generation. | Return on Invested Capital is the only one that considers capital that has been invested and actively used by the company for production of goods and services.
This is why the ROIC only takes into account fixed assets, intangible assets, and current assets of a company, since these represent the investments made by a company to generate revenue. |
| Perspective | ROCE is an important profitability ratio that's used to look at things from the company's perspective.
It is more useful for the company than an investor. | The ROIC is a financial indicator that allows investors to see things from an investor's perspective.
It's more useful for investors because it allows them to determine the potential returns they are likely to get from the capital they have invested. |
| Metric Indicated | The Return on Capital Employed is a good indicator of the company's management ability when it comes to generating revenue. | Return on Invested Capital is a good indicator of the Productivity Of The Company’s Operating Assets. |
| Scope | ROCE considers all capital employed in a company. Its scope is much wider than that of ROIC. | ROIC Is A Subset of Capital Employed by A Company (Invested capital), and its scope is much more refined and precise than ROCE. |
All this being said, ROCE and ROIC both are very similar profitability ratios despite having minor differences. Here's an important point to remember. These ratios are applicable to companies that have capital-intensive business operations, such as manufacturing entities. Service-based businesses are not eligible for ROCE or ROIC.
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