Difference Between ROIC and ROCE
Return on Capital Employed (ROCE) is a measure implies the long term profitability and is calculated by dividing earnings before interest and tax (EBIT) to capital employed, capital employed is the total assets of the company minus all the liabilities, while Return on Invested Capital (ROIC) measures the return the company is earning on the total invested capital and helps in determining the efficiency in which the company is using the investors funds to generate additional income.
Return on Invested Capital (ROIC) and Return on Capital Employed (ROCE) come under profitability ratios that go beyond determining just the profitability of the company. These ratios also help understand how the company is performing and help asses how much of profits made are actually returned to investors. Both these ratios specifically examine how a company utilizes its capital to invest and grow further. ROIC along with ROCE and other ratios are helpful to analysts in assessing a company’s financial condition and forecast the future ability to generate profits.
Both these ratios help in determining how efficiently the company uses the invested capital and are very similar in nature and have few differences mainly in the way these ratios are calculated.
ROIC vs ROCE Infographics
Key Differences
- The higher the ratios the better for both ROCE and ROIC. It means that the company is better utilizing the capital. This indicates that the company is allocating capital in profitable investments.
- Both these ratios are meaningful only when compared to WACC (weighted average cost of capital). If ROIC and ROCE are higher than WACC, then it is an indication that the company has generated value in the financial year.
- If these ratios are lower than the cost of capital it means that the company is in very poor financial health
- Even though calculating ROIC is conceptually straightforward, there are practical issues that also have to be considered. For example, Invested capital does not take into account intangible assets and the amount invested in human capital and goodwill. This investment helps in increasing the profits and are also reflected in cash flow they are not reflected in ROIC
- The drawback of ROCE is that it measures return against book value rather than market value, which means as the assets are depreciated, ROCE will go on increasing even though the cash flows remain the same. This means that older businesses will have a high value, in comparison to new ones which may necessarily not be the case. Cash flow is also affected by inflation. It is also important to note that revenues will also increase with increasing inflation while capital employed does not because the book value of assets is not affected by inflation
ROIC vs ROCE Comparative Table
| ROIC | ROCE | |
| ROIC helps determine the efficiency of the total capital invested. It is a measure that helps determine if the company is allocating the capital in profitable investments | ROCE can be considered as a measure to inspect the efficiency of the companies business operations and measures the profits the company generates with the capital employed | |
| ROIC Formula – Earnings before interest and tax (EBIT)*(1-tax rate) / Invested Capital | ROCE Formula – (Earnings before interest and tax (EBIT) / Capital Employed). To be consistent, the numerator and denominator are taken before interest and tax | |
| Invested capital is a subset of capital employed and is the portion of the capital that is actively used in the business. Invested Capital can be calculated as = Fixed Assets + Intangible Assets + Current Assets – Current Liabilities – Cash | Capital employed in the denominator is calculated as (Debt + Equity – current liabilities). It implies all the capital that is part of the business | |
| This ratio is important from the perspective of an Investor | This ratio is important from the perspective of the Company | |
| ROIC helps in assessing the companies performance within its sector. Cross-sector comparisons using ROIC may not be meaningful. For example, comparing an energy company with IT. It compares the productivity of its operating assets | ROCE looks at the long-term view of the company and asses the ability of the managers. It penalizes the management if ROCE holds too much cash for too long. The trend of ROCE is very important |
Conclusion
ROIC and ROCE are similar in nature only with slight differences. These are vital ratios that help comparisons between companies and help in determining the companies graphs using the past year’s ratios. Both ratios can be helpful in comparing companies that are capital intensive, for example – energy, telecommunication, and auto companies. These measures have limited use when it comes to service-based companies.
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