What is the difference between ROCE and ROI?
Return on capital employed (ROCE) and return on investment (ROI) are two profitability ratios that go beyond a company’s basic profit margins to provide more detailed assessments of how successfully a company conducts its business and returns value to investors. Specifically, both examine the company in terms of how efficiently it utilizes capital to operate, invest and grow. ROCE and ROI, along with other evaluations, can be helpful to analysts in assessing a company’s current financial condition and its ability to generate future profits.
ROCE examines how efficiently a company uses available capital with the following simple equation:
ROCE = Earnings before interest and tax (EBIT) ÷ Capital employed
Capital employed is, in the simplest terms, the total amount of the firm’s assets and revenue minus current liabilities; it’s essentially synonymous with available capital from net profits. The higher the value derived using the above formula, the more efficiently the company is utilizing its capital. It is critical that ROCE at least exceed the cost of capital (financing costs), or the company is in very poor financial condition.
ROCE can be very useful for comparing use of capital by different companies engaged in the same business, particularly in regard to capital-intensive industries such as energy companies, auto companies, and telecommunications firms.
ROI is a popular profit metric used to evaluate company investments and their financial consequences in respect to cash flow. The formula for ROI results in a percentage, and is calculated as follows:
ROI = (Profit from investment – Cost of investment) ÷ Cost of investment
Any value greater than zero reflects net profitability, and higher values indicate more effective use of capital investment. A negative value is considered to be a major warning sign of extremely poor capital management.
ROI can be utilized by companies internally to evaluate the profitability of production of one product versus another, in order to determine which product’s manufacturing and distribution represents the company’s most efficient use of capital.
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