Roic Formula How To Calculate Return On Invested Capital

What is ROIC Formula?

The formula is represented as below,

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Explanation

The “Return” that the company has generated from all the capital it has used up during the period. ROIC calculation is done by using the Net Operating Profit. Once the Operating Profit is calculated, we deduct Tax from the same, as we need Net Profit.

The denominator is the total invested capital by the company during that particular period. It may include capital raised from the market plus the company’s equity.

In this ratio, we are trying to determine the percentage of conversion of capital into returns by the company. Hence, this is used as a profitability ratioProfitability RatioProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more.

Net Operating Profit after Tax

The profit is generated after deducting all possible deductions from the reported sales and profit amount. However, we mention only Tax in the formula as a deduction because; Tax is an essential component in calculating profits. It is an external component paid to the government of the Land. Actual profit has arrived only after Taxes are deducted. Again, if the company is listed in markets, we also need to deduct any dividends from Net Profit to arrive at this numerator.

Total Invested Capital

It is the total amount invested by the company during that particular period. This amount includes its equity plus the debts it has raised from markets (if any).

Example of ROIC Formula (with Excel Template)

Let’s see some simple to an advanced example to understand it better.

Example #1

Company ABC manufactures Copper wires. In the year 2016, its net profits were $500,000. The company management decided to enhance sales and thus profits as an objective for 2017. For doing this, they raised capital in stocks amounting to $2.5M. The retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more to be used for 2017 were $100,000. At the end of 2017, they made a Net profit (after tax deductions) of $575,000 and paid $100,000 as dividends to stockholders. We need to do the calculation of ROIC for 2017.

Net Profit after Tax: $575,000Dividends paid out: $100,000Total Invested Capital: $2,500,000 + $100,000 = $2,600,000

In the below-given template is the data of Company ABC for the ROIC calculation.

So, the Calculation of ROIC of Company ABC will be as follows:

Return on Invested Capital Formula = Net Operating Profit after Tax -Dividends / Total Invested Capital

ROIC =($575,000 – $100,000)

So, Return on Invested Capital will be:

Return on Invested Capital of Company ABC =18.3%

Analysis: The company has a good return capacity. It means that if we invest 2.5M in the company, it generates $575K of profit after all tax deductions, with a capacity to repay $100,000 to its stockholders.

Example #2

Triumph Solutions made a net profit of $500,000 in 2015. The total invested capital is $1,800,000 for the year. The legal tax rate is 40%. Calculate the ROIC for Triumph Solutions for 2015.

In the below-given table is the data of Triumph Solutions for the calculation of ROIC.

Therefore, the Calculation of ROIC of Best Paints Ltd will be as follows,

ROIC = $100,000 /$2,000,000

So, Return on Invested CapitalReturn On Invested CapitalReturn on Invested Capital (ROIC) is a profitability ratio that shows how a company uses its invested capital, such as equity and debt, to generate profit. The reason this ratio is so crucial for investors before making an investment is that it helps them decide which firm to invest in.read more of Best Paints Ltd will be:

ROIC of Best Paints Ltd = 5.0%

Analysis: ROIC for the firm is only 5%. However, it should be noted that the total invested capital of $2M for the year, the major component is equity ($1.2M), with a debt of only $0.8M. Hence, the company would have to repay more to the investors than the debt holders.

Example #3

Triumph Solutions makes a net profit of $500,000 in 2015. The total invested capital is $1,800,000 for the year. The legal tax rate is 40%. Calculate the ROIC for Triumph Solutions for 2015.

In the below-given table is the data of Triumph Solutions for calculation of ROIC.

Net Profit (before taxes): $500,000Total invested capital: $1,800,000Tax Rate: 40%

Therefore, Calculation of ROIC of Triumph Solutions will be as follows,

ROIC=$500,000 (1-0.4) / $1,800,000

So, Return on Invested Capital of Triumph Solutions will be:

ROIC of Triumph Solutions =16.67%

ROIC Calculator

Relevance and Uses

ROIC is majorly used while analysts are working on company analysis. Majorly it is relevant for the following uses:

ROIC Formula measures how well a company can convert its capital into returns. Hence, this ratio helps investors understand returns from their investments.With results calculated over a while for a particular company, one can follow the company’s growth pattern and use this trend for forecasting the company’s typical plans in the future.ROIC sometimes also suggests the capital structure of the company. With the breakup of the total invested capital to equity and debt, one can try to analyze the debt and equity ratioDebt And Equity RatioThe debt to equity ratio is a representation of the company’s capital structure that determines the proportion of external liabilities to the shareholders’ equity. It helps the investors determine the organization’s leverage position and risk level. read more invested by the firm and, after that, understand its related future prospects. Analyzing ROIC over time can enable the company to understand its growth trend and make suitable decisions for future investments, renewals, and liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more of existing debt components.

Conclusion

ROIC is a measure of the income generated by a company from its investments. The better the ratio, the better and more profitable it is to invest in the company. However, it is essential to understand that the denominator used is “total invested capitalInvested CapitalInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash read more,” not debt or equity. Hence, analyzing the structure of its components would give a much better understanding to investors and analysts. A higher debt component may also mean that the company is using up its debt to generate returns – it may require to repay a higher component of returns to its loans.

Thus, a complete and true understanding of the company’s returns would only be made after each component of the numerator and denominator are properly analyzed.

What is ROIC Formula?#

Explanation#

Net Operating Profit after Tax#

Total Invested Capital#

Example of ROIC Formula (with Excel Template)#

Example #1#

Example #2#

Example #3#

ROIC Calculator#

Relevance and Uses#

Conclusion#

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