Return on Average Capital Employed Formula

Financial Statement Analysis

Return on Average Capital Employed Formula (Table of Contents)

ROACE Formula
Return on average capital employed Calculator
ROACE Template

Return on Average Capital Employed (ROACE) Formula

Why the investors invest in a company? It’s because they want to grow with the company. Return on average capital employed helps them find out whether they should invest in the company or not.

ROACE formula is not similar as return on capital employed (ROCE). Here we are calculating the return on the average capital employed. That’s why we need to consider both the beginning capital employed and the ending capital employed.
ROACE formula is a profitability ratio and it helps investors find out how much return they may get from the investments they would make in the company.

Here’s the formula of ROACE –

Also, checkout this detailed article on ROCE

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Example of ROACE Formula

Let’s take a simple example to illustrate ROACE formula.

Benefit 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.
Using the return on average capital employed formula, we get –
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 31^st 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
Return on Average Capital Employed = CHF 12,408 / 95,613 = 12.98%

Explanation of Return on Average Capital Employed Formula

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 profit, 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 average capital employed. To find out the capital employed, we can take two approaches.
- The first approach is we can simply add the equity and the 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).

Use of Return on Average Capital Employed Formula

Return on average capital employed formula is best used for capital-intensive industries.
For companies which need a lot of capital upfront 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 the capital assets. It may so happen that these capital assets are depreciated and as a result the return on average capital employed 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 Return on Average Capital Calculator.

EBIT
Average Capital Employed
ROACE Formula =

ROACE Formula =

EBIT
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Average Capital Employed

0
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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 return on average capital employed template here – Return on Average Capital Employed Excel Template