Formula to Calculate Return on Average Capital Employed (ROACE)
Return on Average Capital Employed (ROACE) is an extension of the ratio Return on Capital Employed and instead of the total capital at the end of the period, it takes an average of the opening and the closing balance of capital for a period of time and is calculated by dividing the Earning before interest and taxes (EBIT) by Average total assets minus all the liabilities.
Also, check out this detailed article on ROCEROCEReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed.
In the above ratio, we have two parts.
- The first part is EBIT (earnings before interests and taxes). EBIT is actually operating income. If we look at the income statement of the company, we would see that after deducting the operating expenses from the gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services., we get operating income or EBIT. You may ask why we are taking EBIT into consideration instead of net income. It’s because operating income directly reflects the income generated from the business; moreover, operating income doesn’t include income from other sources.
- The second part is the average capital employed. To find out the capital employedFind Out The Capital EmployedCapital employed indicates the company's investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. "Capital Employed = Total Assets - Current Liabilities" or "Capital Employed = Non-Current Assets + Working Capital.", we can take two approaches.
- The first approach is we can simply add equity and long-term debt.
- But there’s a second approach which is better than the first approach. In the second approach, we deduct the current liabilities from the total assets, or we can add up equity and the non-current liabilities.
- The second approach is better because it directly shows what has been directly invested in the business (meaning this approach also includes other non-current liabilities other than debt).
Let’s take a simple example to illustrate the ROACE formula.
Benefits Inc. has the following information –
- EBIT for the year – $30,000
- The beginning capital employed – $540,000
- The ending capital employed – $450,000
Find out the ROACE.
First, we need to find out the average capital employed.
All we need to do is to do a simple average.
- Average Capital Employed = ($540,000 + $450,000) / 2 = $990,000 / 2 = $495,000.
- ROACE formula= EBIT / Average Capital Employed
- Or, ROACE formula = $30,000 / $495,000 = 6.06%.
Nestle Return on Average Capital Employed
Below is the snapshot of Nestle’s Income Statement and Balance Sheet. For calculating ROACE, we require EBIT or the Operating profit.
Consolidated income statement for the year ended 31st December 2014 & 2015
source: Nestle Annual Report
Here three figures are important, and all of them are highlighted. First is the Operating Profit for 2014 and 2015. And then, the total assets and total current liabilities for 2014 and 2015 are needed to be considered.
- Operating Profit of 2015 = CHF 12,408
- Capital Employed (2015) = 123,992 – 33,321 = 90,671
- Capital Employed (2014) = 133,450 – 32,895 = 100,555
- Average Capital Employed = (90,671 + 100,555)/2 = 95,613
- ROACE = CHF 12,408 / 95,613 = 12.98%
- Return on average capital employed is best used for capital-intensive industries.
- For companies that need a lot of capital up front to start and run the business are capital intensive industries. For capital-intensive industries, the ROACE would be lower.
- In other cases (if the company is not capital intensive), the ROACE should be higher.
- An investor should be careful about capital assets. It may so happen that these capital assets are depreciated, and as a result, the ROACE has been higher. But it is not because the profit is higher; rather, the ROACE is lower.
Return on Average Capital Employed Calculator
You can use the following calculator.
|ROACE Formula =||
Return on Average Capital Employed in Excel (with excel template)
Let us now do the same example above in Excel. This is very simple. First, you need to find out the average capital employed, and you need to provide the two inputs of Ebit and Average Capital Employed.
You can easily calculate the ratio in the template provided.
You can download this template here – Return on Average Capital Employed Excel Template.
Return on Average Capital Employed Formula Video
This has been a guide to return on average capital employed formula, its uses along with practical examples. Here we also provide you with ROACE Calculator with a downloadable excel template. Learn more from the below articles –