Return on Capital Employed is a type of Profitability Ratio that determines the Profit of a company relative to Capital Employed in a company. It is a measure of how efficiently a company is using the Capital to create profit.
$$Return\quad on\quad Capital\quad Employed=$$$$\frac { Operating\quad Profit(EBIT) }{ Capital\quad Employed }$$
Operating Profit or EBIT (Earnings Before Interest and Taxes) = Net Sales – (Operating Expenses + Cost of Goods Sold)Where,
Capital Employed = Equity Share Capital + Reserves and Surplus + Long Term Debts
⇨ Rs. 6500000.00
ROCE = EBIT / Capital Employed = 1500000 / 6500000
$$Return\quad on\quad Capital\quad Employed=$$$$\frac { Operating\quad Profit(EBIT) }{ Capital\quad Employed }$$
Operating Profit or EBIT (Earnings Before Interest and Taxes) = Net Sales – (Operating Expenses + Cost of Goods Sold)Where,
- And Capital Employed = Total Assets – Current Liabilities or Equity + Non-Current Liability
- Return on Capital Employed (ROCE) multiplied by 100 provides the ROCE in percentage terms.
Significance and Interpretation
- Return on Capital Employed (ROCE) is an important indicator of the profitability of a company, unlike other profitability ratios it considers the profit with respect to equities as well as liabilities. Higher ROCE attracts investors to invest in a company.
- High ROCE implies that the Capital of a company are well utilized to generate profits whereas a low ROCE implies underutilization of the Capital of the Company. Hence, a high ROCE attracts investors.
Examples
Example 1:
Given below are few details of M/S XYZ Ltd., use them an calculate the Return on Capital Employed for M/S XYZ Ltd.Particulars | Amount (in Rs.) |
---|---|
Equity Share Capital | 4500000.00 |
Reserves and Surplus | 1500000.00 |
Long Term Debts | 500000.00 |
Short Term Debts | 1000000.00 |
Operating Profit | 1500000.00 |
Solution:
Operating Profit (EBIT) = Rs. 1500000.00Capital Employed = Equity Share Capital + Reserves and Surplus + Long Term Debts
⇨ Rs. 6500000.00
ROCE = EBIT / Capital Employed = 1500000 / 6500000
⇨ 3 / 13
Hence, ROCE = 3/13 or 0.2307 or 23.07%
Hence, ROCE = 3/13 or 0.2307 or 23.07%