Definition
ROIC stands for Return on Invested Capital and calculates the percentage return that a company makes over its invested capital, providing a measure of how well a company is using its money to generate profits. On the other hand, ROCE stands for Return on Capital Employed, which measures a company’s profitability in terms of all of its capital, both debt and equity. Therefore, while both are profitability ratios, ROIC focuses on the funds specifically invested by shareholders and bondholders, whereas ROCE considers all capital, including debt.
Key Takeaways
- ROIC (Return on Invested Capital) and ROCE (Return on Capital Employed) are financial performance metrics. ROIC gauges how effectively a company is investing its capital, while ROCE is often used to measure a company’s profitability and the efficiency with which its capital is employed.
- Both metrics assess a company’s capacity to generate returns from its investments, but they use slightly different computations. ROIC takes into account operating income after tax divided by total invested capital, while ROCE calculates operating profit (or EBIT) divided by total assets minus current liabilities (or capital employed).
- While both are useful, their efficacy depends on the context. ROIC is more effective for companies with significant debt, as it accounts for the cost of capital. On the other hand, for businesses with minimal debt, ROCE can provide a better understanding of efficiency as it includes short-term liabilities, which represent a significant portion of operational capital for many businesses.
Importance
ROIC (Return on Invested Capital) and ROCE (Return on Capital Employed) are both crucial financial metrics that help investors and companies measure the profitability and efficiency of capital usage.
While ROIC focuses purely on the capital invested by shareholders and debtholders, ROCE considers all long-term capital, including debt, equity, and reserves.
Both metrics are used to evaluate how well a company generates returns from its entire capital base.
Comparing ROIC to ROCE can provide deeper insights on a company’s efficiency in using different forms of financing, ultimately helping decision-making about investment strategies, capital allocation or simply evaluating the overall financial health of the firm.
Explanation
Return on Invested Capital (ROIC) and Return on Capital Employed (ROCE) are both important financial metrics that are pivotal for assessing the efficiency and profitability of a company. Their purpose is to measure how effectively a company can generate returns from the capital it has deployed. Both the metrics provide an understanding of a firm’s capital efficiency, helping investors to judge the company’s profitability and growth potential.
They are critical in comparing a company’s performance to its peers and determining whether the company is yielding an adequate return. Though seemingly similar, ROIC and ROCE serve slightly different purposes. ROIC comprehends the long-term return and is used primarily to assess a company’s efficiency at allocating its capital to profitable investments.
It provides an idea of how well a company is using its money to generate returns, excluding external financing. On the other hand, ROCE is more effective for short-term analysis. It is used for comparing the performance of companies within the same industry, and is especially useful in industries that require significant investments in fixed assets.
It accommodates for companies that have a mixture of debt and equity financing, thus giving a fuller picture of a company’s effectiveness in generating returns from all available capital.
Examples of ROIC vs ROCE
ROIC (Return on Invested Capital) and ROCE (Return on Capital Employed) are both key financial metrics for evaluating a company’s profitability and value. They measure the efficiency with which a company generates profit from its capital, but use slightly different calculations and interpretations. Here are three real-world examples:**Microsoft Corp (ROIC vs. ROCE):** As of 2020, Microsoft had a ROIC of40% and a ROCE of
7%. While both figures are high, indicating that Microsoft is using its capital effectively, the difference in values might be caused by the types of capital being accounted for in each calculation. ROCE takes into account all capital whereas ROIC excludes some forms of current liabilities.**Starbucks Corporation (ROIC vs. ROCE):** In 2020, Starbucks had a ROIC of3% and a ROCE of
2%. Both indicators show above-average values but the ROCE is higher because it accounts for debt financing in its calculation, which might suggest Starbucks had a significant amount of debt that year.**Tesla, Inc. (ROIC vs. ROCE):** For 2020, Tesla had a ROIC of94% and a ROCE of
15%. These percentages are relatively low compared to the other companies above due to Tesla’s high capital expenditures in its growth strategy. The slight difference seen here again results from the differing types of capital and financing accounted for in each calculation.
FAQ: ROIC vs ROCE
What is ROIC?
ROIC, or Return on Invested Capital, is a profitability or performance measure that aims to gauge the percentage return that a company is making from its invested capital. It helps investors understand how effectively a company is converting its investment capital into profits.
What is ROCE?
ROCE, or Return on Capital Employed, is a financial ratio that measures a company’s profitability and the efficiency with which its capital is used. In other words, the ratio tells investors how effectively a company is using its capital to generate profits.
How are ROIC and ROCE different?
Both ROIC and ROCE gauge a firm’s profitability, but they consider different forms of capital. ROIC calculates return on the total capital invested in the firm, including debt and equity. On the other hand, ROCE considers only the capital that is employed, i.e., not including excess cash and non-operating assets.
Which is a better measure – ROIC or ROCE?
Neither is strictly better – they serve different purposes and are useful in different contexts. ROIC is much more concerned with profitability, so it’s better for companies focusing on their bottom line. ROCE, on the other hand, is more about efficiency, so it’s more useful for companies needing to optimize their asset usage. Hence the importance of each ratio varies with the use-case scenarios and the industries where they are employed.
Related Entrepreneurship Terms
- Investment Efficiency
- Capital Employed
- Long-term Investments
- Net Operating Profit
- Company Performance Evaluation
Sources for More Information
- Investopedia: This is a large and comprehensive online resource dedicated to investing and personal finance. It features an extensive dictionary of financial terms.
- Coursera: An online platform that offers courses from top universities around the world, including quite a few on finance and accounting that likely cover topics like ROIC and ROCE.
- Corporate Finance Institute (CFI): A leading provider of online finance courses and certifications, including detailed explanations of various finance and accounting terms and concepts.
- Khan Academy: A nonprofit educational organization with video lessons on a wide variety of subjects, including finance and capital markets. Particularly good for visual learners.
