Return on capital employed, or ROCE, measures how well a company earns operating profit from all the long-term capital used in the business, both equity and debt. It is calculated by dividing earnings before interest and tax, called EBIT, by capital employed, which is total assets minus current liabilities or equivalently equity plus long-term borrowings. Because it ignores how the business is financed, ROCE is useful for comparing firms with different amounts of debt, and it is especially relevant for capital-intensive industries like manufacturing, infrastructure and utilities. A ROCE that is higher than the company’s cost of borrowing means the business creates value from the funds it raises; a ROCE lower than the interest rate it pays signals value destruction. Investors usually prefer a ROCE that is stable or rising over several years, and many look for figures above 15 percent, though norms differ by sector. When an IPO raises money to repay debt, ROCE may improve because interest costs fall and capital employed shrinks. Offer documents list ROCE among the key performance indicators, and the formula used is explained in the footnotes, so read it before comparing across companies.
Example: A company earns EBIT of Rs 40 crore on capital employed of Rs 200 crore. ROCE is 20 percent. If its loans cost 11 percent a year, the business is earning well above its cost of funds.