The return on capital employed is very similar to the return on assets (ROA), but is slightly different in that it incorporates financing. Because of this the ROCE calculation is more meaningful than the ROA. The ROCE is generally used to find out how efficient and profitable a company is from year to year. As it is a percentage a company can locate problems or areas of improvement with the fluctuation of this ratio from year to year.
The return on capital employed equation is as follows:
ROCE = EBIT or NI/(Total Assets – Current Liabilities)
Note: The earnings before interest and taxes, known as the operating income, is normally used, but people can also use the Net Income if they would like to incorporate the net interest and taxes into the ROCE formula.
Tim found that the ROCE last year is 16%. He would like to compare this number to the current ROCE. He begins by finding the following numbers in the Balance Sheet as well as the Income Statement:
Net Income = $50,000
Total Assets = $360,000
Current Liabilities = $35,000
ROCE = $50,000/($360,000 – $35,000) = 15%
Note: The drop in this number means that Tim’s company is not as efficient as it used to be or that it decreased it current liabilities.
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