How to calculate return on capital employed (ROCE)

If you’re trying to understand the profitability of your business, the return on capital employed (ROCE) formula is a useful tool. ROCE helps you to understand the profit you’re making from the money you’re putting into your business.

As well as being used by business owners, return on capital employed is also used by prospective investors. So if you’re looking to get funding, being able to provide your ROCE could help your business to stand out against the competition.

Read on to find out the return on capital employed formula and how to work it out for your business.

What is return on capital employed (ROCE)?

Firstly, it’s important to understand the definition of capital employed. This is how a business invests the money it makes back into itself.

The money a business invests as capital employed could be spent on things such as:

• equipment used to run the business
• hiring new employees
• buying more stock
• renting a new premises

Return on capital employed is a calculation used to work out how much money a business is making based on the money it invests. As well as profitability, ROCE is used to measure efficiency.

Read more: How to calculate profit margin

How to calculate ROCE

To work out your return on capital employed, you’ll need to know your capital employed and your earnings before interest and tax (known as EBIT).

You can calculate your capital employed by subtracting your current liabilities from your total assets. Another way to work out capital employed is to add your fixed assets to your working capital.

All this information can be found on your balance sheet.

To work out your EBIT, you’ll need to subtract your costs of goods or services sold and your operating costs from your revenue.

Read our guide to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for more information.

What is the return on capital employed formula?

Once you’ve worked out your capital employed and your EBIT, you’re ready to do your ROCE calculation.

Here’s the ROCE formula you can use:

ROCE = EBIT / capital employed

Return on capital employed example

A small glassware company has liabilities (e.g. income tax and accounts payable) of £30,000 and total assets (things like cash, property, and equipment) of £150,000.

The liabilities (£30,000) subtracted from the assets (£150,000) means the business has a capital employed of £120,000.

The business has annual revenue of £130,000 and total costs of £100,000. This means its EBIT is £30,000.

So, the EBIT of £30,000 divided by the capital employed of £120,000 leaves the company with a ROCE of 0.25 (expressed as a percentage of 25 per cent).

What is a good percentage for return on capital employed?

When it comes to ROCE, the higher the percentage, the better. The aim is to make the biggest return possible on the money you’re investing in the business. The more you make as a percentage of your investment, the higher your return on capital employed will be.

It’s generally considered that a healthy ROCE is around 15 per cent to 25 per cent. However, it’s important to note that averages fluctuate by industry.

Advantages and disadvantages of ROCE

Like all financial performance metrics, return on capital employed has its pros and cons.

5 ROCE advantages

Some of the main reasons why businesses track their return on capital employed include:

1. You can get an idea of your future profitability as well as the business’s current level of efficiency.
2. ROCE is expressed as a percentage, which makes it easy to understand.
3. It’s relatively simple to work out if you have the right figures available.
4. Investors often want to know a business’s ROCE, so it can be useful if you’re looking for funding.
5. ROCE can be used to compare businesses within the same industry.

5 ROCE disadvantages

And here are some reasons why return on capital employed might not work for your business:

1. Although ROCE indicates future profitability, it’s based on past performance so may not give an accurate reflection of where your business is going if you’ve made a lot of changes in a short period of time.
2. It doesn’t account for things like cash flow or revenue growth, so may not give a full picture of your financial health.
3. ROCE for businesses in different sectors and industries will vary, so it’s not a very useful comparison tool.
4. It doesn’t account for economic conditions, such as a cost of living crisis where consumers are spending less.
5. ROCE should be used as one of several tools to measure the overall performance of a business.

Why do potential investors want to know your ROCE?

Whether you’re looking for angel investment or venture capital, it’s likely that potential investors will want to know your business’s ROCE.

They’ll use this figure to work out how much return on investment they might get in the future. A steady ROCE over time or one that’s rising is usually seen as a positive investment sign.

If you’re able to share a strong ROCE, your business is likely to be appealing to investors and you could attract a higher cash injection.

Read more: How to find investors for a business

ROCE vs ROIC – what is the difference?

Return on invested capital (ROIC) also measures profitability and efficiency and gives a similar result to ROCE.

The key difference is that it takes a business’s tax obligations into account. This makes it a more detailed and complex analysis of performance.

Do you have any unanswered questions about working out return on capital employed for your business? Let us know in the comments.

More finance guides for small businesses

• What is a disbursement? A small business guide
• Small business funding – how to get a cash boost for your business
• What is a variable cost? A guide for businesses
• How much business insurance do I need?