Formula to Calculate Return on Average Capital Employed (ROACE)

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Also, check out this detailed article on ROCEROCEReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed.read more

Explanation

In the above ratio, we have two parts.

Key Takeaways

  • The return on average capital employed considers the closing and opening balances instead of the total capital employed.Calculate this by dividing the earnings before tax and interest by the average capital employed. It is a metric for assessing the productivity of the firm. The EBIT (earnings before interests and taxes) and the average capital employed are included in the two parts of the ratio. Companies use this measure for industries that are capital-intensive and require a considerable amount of base capital.

  • The first part is EBIT (earnings before interests and taxes). EBIT is operating incomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business.read more. If we look at the company’s income statement, we would see that after deducting the operating expenses from the gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more, we get operating income or EBIT. You may ask why we are considering EBIT instead of net income. Operating income directly reflects the income generated from the business; moreover, operating income doesn’t include income from other sources.The second part is the average capital employed. To find out the capital employedFind Out The Capital EmployedCapital employed indicates the company’s investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. “Capital Employed = Total Assets - Current Liabilities” or “Capital Employed = Non-Current Assets + Working Capital.“read more, we can take two approaches. The first approach can simply add equity and long-term debt.But there’s a second approach that is better than the first approach. In the second approach, we deduct the current liabilities from the total assets or add up equity and the non-current liabilities.The second approach is better because it directly shows what has been directly invested in the business (meaning this approach also includes other non-current liabilities other than debt).

Example

Let’s take a simple example to illustrate the ROACE formula.

  • The first approach can simply add equity and long-term debt.But there’s a second approach that is better than the first approach. In the second approach, we deduct the current liabilities from the total assets or add up equity and the non-current liabilities.The second approach is better because it directly shows what has been directly invested in the business (meaning this approach also includes other non-current liabilities other than debt).

Benefits Inc. has the following information –

  • EBIT for the year – $30,000The beginning capital employed – $540,000The ending capital employed – $450,000

Find out the ROACE.

First, we need to find out the average capital employed.

All we need to do is to do a simple average.

  • Average Capital Employed = ($540,000 + $450,000) / 2 = $990,000 / 2 = $495,000.ROACE formula= EBIT / Average Capital EmployedOr, ROACE formula = $30,000 / $495,000 = 6.06%.

Nestle Return on Average Capital Employed

Below is the snapshot of Nestle’s Income Statement and Balance Sheet. For calculating ROACE, we require EBIT or the Operating profit.

Consolidated income statement for the year ended 31st December 2014 & 2015

source: Nestle Annual Report

Here three figures are important, and all of them are highlighted. First is the Operating Profit for 2014 and 2015. And then, the total assets and total current liabilities for 2014 and 2015 are needed to be considered.

  • Operating Profit of 2015 = CHF 12,408Capital Employed (2015) = 123,992 – 33,321 = 90,671Capital Employed (2014) = 133,450 – 32,895 = 100,555 Average Capital Employed = (90,671 + 100,555)/2 = 95,613ROACE = CHF 12,408 / 95,613 = 12.98%

Uses

  • Return on average capital employed is best used for capital-intensive industries.Companies that need a lot of capital upfront to start and run the business are capital-intensive industries. For capital-intensive industries, the ROAD would be lower.In other cases (if the company is not capital intensive), the ROACE should be higher.An investor should be careful about capital assets. It may so happen that these capital assets are depreciated, and as a result, the ROACE has been higher. But it is not because the profit is higher; rather, the ROACE is lower.

Return on Average Capital Employed Calculator

You can use the following calculator.

Return on Average Capital Employed in Excel (with excel template)

Let us now do the same example above in Excel. This is very simple. First, you need to find out the average capital employed and provide the two inputs of Ebit and Average Capital Employed.

You can easily calculate the ratio in the template provided.

You can download this template here – Return on Average Capital Employed Excel Template.

Return on Average Capital Employed Formula Video

This has been a guide to return on average capital employed formula, its uses, and practical examples. Here we also provide you with ROACE Calculator with a downloadable excel template. Learn more from the below articles –

The return on capital employed is the total amount of assets a business utilizes instead of its liabilities. It helps the investors understand how well the business uses its assets. However, return on average capital employed construes the average liabilities and assets, the closing and opening balances.

A decent figure for this depends on the industry benchmark. Presently, a benchmark of 35% would be prevalent. Thus, any company with a ROACE of 20% would look good.

To improve the return on average capital employed, the firm can start by paying off liabilities and increasing sales to earn enough revenue to acquire more assets; the overall balance sheet would look desirable.

  • Total Expense Ratio FormulaTotal Expense Ratio FormulaThe total expense ratio is the total investment cost to the investor who invests in a mutual fund, equity fund or exchange-traded fund. It included the transactional costs of investment, legal, management, auditor fees and many other miscellaneous operational expenses determining the final return on the investment.read moreReturn on Net Assets ExamplesReturn On Net Assets ExamplesReturn on net assets determines the efficiency of the company’s net assets to generate profit. It analyzes the income-generating ability of the net working capital and the fixed assets employed in the business.read moreCalculate Return on SalesHow to Calculate Capital Loss Carryover?How To Calculate Capital Loss Carryover?Capital loss carryover is the benefit that has been extended to the taxpayers for claiming the capital losses that were incurred during the year, to be set off against the subsequent capital gains. US Tax Laws allow a maximum deduction of $3,000 in a year in the case of an individual.read more