Difference Between ROIC and ROCE
Return on Capital Employed (ROCE) is a measure that implies long-term profitability and is calculated by dividing earnings before interest and tax (EBIT) by capital employed, capital employed is the total assets of the company minus all the liabilities. In contrast, Return on Invested Capital (ROIC) measures the company’s return on the total invested capital. It helps determine the efficiency in which the company is using the investor’s funds to generate additional income.
Return on Invested Capital (ROICROICReturn on Invested Capital (ROIC) is a profitability ratio that shows how a company uses its invested capital, such as equity and debt, to generate profit. The reason this ratio is so crucial for investors before making an investment is that it helps them decide which firm to invest in.) and Return on Capital Employed (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.) come under profitability ratios that go beyond determining just the company’s profitability. 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 forecasting the future ability to generate profits.
These ratios also help understand how the company is performing and help assess how much of profits are returned to investors.
These ratios help determine how efficiently the company uses theInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash invested capitalInvested CapitalInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash and are very similar and have few differences, mainly in the way these ratios are calculated.
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ROIC vs. ROCE Infographics
- The higher the ratios, the better for both ROCE and ROIC. It means that the company is better at utilizing capital. It indicates that the company is allocating capital in profitable investments.
- These ratios are meaningful only when compared to WACCWACCThe weighted average cost of capital (WACC) is the average rate of return a company is expected to pay to all shareholders, including debt holders, equity shareholders, and preferred equity shareholders. WACC Formula = [Cost of Equity * % of Equity] + [Cost of Debt * % of Debt * (1-Tax Rate)] (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 feeble financial health.
- Even though calculating ROIC is conceptually straightforward, practical issues also have to be considered. For example, Invested capital does not consider intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. and the amount invested in human capital and goodwill. This investment helps in increasing the profits and is 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. It means that older businesses will have a high value compared to new ones, which may not necessarily be the case. Cash flow is also affected by inflation. It is also important to note that revenues will also increase with increasing inflation, whileCapital 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." capital employedCapital 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." does not because the book value of assets is not affected by inflation.
ROIC vs. ROCE Comparative Table
ROIC and ROCE are similar only with slight differences. These are vital ratios that help comparisons between companies and help in determining the company’s graphs using the past year’s ratios. Both ratios can help compare companies that are capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining., for example – energy, telecommunication, and auto companies. These measures have limited use when it comes to service-based companies.
This article has been a guide to ROIC vs. ROCE. Here we discuss the top difference between ROIC and ROCE, infographics, and a comparison table. You may also have a look at the following articles –