How efficiently or profitably is the company utilising overall debt and equity funding?
The return on capital employed (ROCE) ratio, expressed as a percentage, complements the return on equity (ROE) ratio by adding a company’s debt liabilities, or funded debt, to equity to reflect a company’s total “capital employed”. This measure narrows the focus to gain a better understanding of a company’s ability to generate returns from its available capital base.
By comparing net income to the sum of a company’s debt and equity capital, investors can get a clear picture of how the use of leverage impacts a company’s profitability. Financial analysts consider the ROCE measurement to be a more comprehensive profitability indicator because it gauges management’s ability to generate earnings from a company’s total pool of capital.
ROCE = EBIT / Capital Employed
Capital Employed = Debt Liabilities + Shareholders’ Equity
The return on capital employed is an important measure of a company’s profitability. Many analysts think that factoring debt into a company’s total capital provides a more comprehensive evaluation of how well management is using the debt and equity it has at its disposal.
ROCE is a key, if not the key, ratio to gauge a company’s profitability. An ROCE ratio, as a general rule, should be at or above a company’s average borrowing rate.