Introduction
When it comes to analyzing a company’s financial performance, there are a lot of ratios and metrics to consider. Two of the most important ones are ROCE and ROIC. ROCE stands for Return on Capital Employed, while ROIC stands for Return on Invested Capital. While they may seem similar, there are some key differences between the two.
What is ROCE?
ROCE is a measure of how efficiently a company is using its capital to generate profits. It is calculated by dividing earnings before interest and taxes (EBIT) by the total capital employed. Total capital employed includes both equity and debt.
Formula for ROCE:
ROCE = EBIT / Total Capital Employed
What is ROIC?
ROIC, on the other hand, is a measure of how much return a company is generating on the money invested in the business. It takes into account both equity and debt, but it also deducts the value of any excess cash and investments that the company holds.
Formula for ROIC:
ROIC = NOPAT / Invested Capital
Key Differences Between ROCE and ROIC
While both ratios are used to measure a company’s financial performance, there are some key differences between the two.
1. Calculation Method
ROCE is calculated by dividing EBIT by total capital employed, while ROIC is calculated by dividing NOPAT by invested capital. The difference lies in the way that excess cash and investments are treated.
2. Treatment of Excess Cash and Investments
ROIC deducts the value of any excess cash and investments that the company holds, while ROCE does not. This means that ROIC gives a more accurate picture of how much return the company is generating on the money that has been invested in the business.
3. Focus on Operating Performance
ROIC focuses more on a company’s operating performance, while ROCE is more of a measure of how efficiently a company is using its capital. This is because ROIC deducts the value of excess cash and investments, which are not directly related to a company’s operating performance.
Which Ratio is Better?
There is no clear answer to this question, as it depends on what you are trying to measure. If you are looking to measure how efficiently a company is using its capital, then ROCE is the better ratio to use. However, if you are looking to measure how much return a company is generating on the money invested in the business, then ROIC is the better ratio to use.
Conclusion
ROCE and ROIC are both important ratios that are used to measure a company’s financial performance. While they may seem similar, there are some key differences between the two. ROCE measures how efficiently a company is using its capital to generate profits, while ROIC measures how much return a company is generating on the money invested in the business. Ultimately, the choice between the two ratios depends on what you are trying to measure.
