Return on capital employed (ROCE) is a percentage worked out by dividing a company's operating profit, called earnings before interest and tax (EBIT), by its capital employed, which is total assets minus current liabilities, and then multiplying by 100. Capital employed is also equal to equity plus non current liabilities.
For investors asking what is ROCE in simple terms, it shows the operating profit a company earns for every Rs 100 of capital it uses. A higher percentage means more operating profit from the same capital.
How the formula and its variants work
The basic calculation is EBIT divided by capital employed, multiplied by 100. For EBIT of Rs 200 crore and capital employed of Rs 1,000 crore, the ROCE will be 20%.
ROCE is not defined in SEBI is the statutory regulator of India's securities market, with the legal duty to protect investors and to promote and regulate that market. Read the full meaning of SEBI, RBI or stock exchange rules, so it is an analyst convention and each source may calculate it in its own way.
One version divides EBIT by the average of opening and closing capital employed. Other definitions use operating profit after tax in the numerator, divided by average capital employed.
The same company shows different percentages under each version, so the formula needs to be stated whenever a figure is quoted.
Why ROCE differs so much between businesses
Indian screeners show ROCE company by company and asset light firms show far higher figures than capital heavy ones. As a hypothetical case, a software company with few fixed assets may show ROCE above 50%, while a shipbuilder with heavy plant and machinery may show a figure closer to 20%.
Investors use such figures to compare companies in the same industry, as the usual level of ROCE differs widely from one sector to another.
ROCE is often confused with return on invested capital (ROIC). ROCE uses pre-tax operating profit over all long term capital, while ROIC uses net operating profit after tax (NOPAT) over invested capital, so the two figures differ for the same company. ROCE is also compared with Return on equity is the net profit after tax of a company divided by its shareholders' net worth, multiplied by 100 and shown as a percentage. Read the full meaning of ROE (Return on Equity) (ROE), which divides net profit after tax by the shareholders' net worth alone. ROE leaves out borrowed money, so a company with heavy debt can show a high ROE and a lower ROCE.