Return on capital employed (ROCE)

Return on capital employed (ROCE) measures operating earnings relative to the long-term capital committed to a business. It helps answer whether management is producing an adequate operating return from the funds supplied by owners and long-term creditors.

When to use it

• Answer the key performance question: “How well are we generating earnings from our capital investments?”
• Include the KPI in the financial perspective.
• Compare capital productivity across periods, business units or genuinely similar companies.
• Test whether returns exceed the cost of the capital used to produce them.

Origins

ROCE developed from the broader tradition of return-on-investment and financial-ratio analysis. Early industrial management systems, including the DuPont return framework, decomposed profit relative to invested capital into margin and asset use. ROCE became a common British and international accounting term, but no single definition or inventor governs current practice.

What it is

Perspective: Financial perspective.

Key performance question: How well are we generating earnings from our capital investments?

ROCE normally compares earnings before interest and tax (EBIT) with capital employed. EBIT is the numerator, not the denominator: it represents operating earnings before the financing cost owed to providers of debt and equity.

Capital employed can be defined as total assets less current liabilities, or equivalently as equity plus long-term interest-bearing finance when classifications reconcile. The definition should match the operating scope of the numerator. Return on average capital employed (ROACE) uses an average balance, which is usually preferable when capital changes materially during the period.

A higher ROCE can indicate stronger margin, more efficient capital use or both. It can also result from old depreciated assets, disposals, underinvestment or accounting changes. The ratio should be decomposed and considered with cash flow, growth, asset condition and risk.

How to use it

Measurement