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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.
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:
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
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.
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
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).
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.
Like all financial performance metrics, return on capital employed has its pros and cons.
Some of the main reasons why businesses track their return on capital employed include:
And here are some reasons why return on capital employed might not work for your business:
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
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.
Conor Shilling is a Copywriter at Simply Business with over two years’ experience in the insurance industry. A trained journalist, Conor has worked as a professional writer for 10 years. His previous experience includes writing for several leading online property trade publications. Conor specialises in the buy-to-let market, landlords, and small business finance.
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