ROIC vs ROCE

Difference Between ROIC vs ROCE

Two of the most common, yet important metrics that investors rely on while evaluating companies are ‘Return on Invested Capital (ROIC)’ and ‘Return on Capital Employed (ROCE)’. ROIC and ROCE are the important profitability ratios that help the investor in making a well-informed investment decision. Return on Invested Capital(ROIC) gives a more granular view of the profitability of the business. It is a metric that shows the return generated on the capital that is actually invested in the business. ROCE is a metric that compares return, relative to the capital employed in the business. It aims to find out the return relative to the capital that is actually invested in the business.

Before digging any deeper, let us first understand what these terms signify.

Return on Invested Capital (ROIC):

The formula for calculating ROIC is as follows;

ROIC: Net operating profit/ Invested capital

Invested capital is the capital that is being actively used in the business. Therefore, invested capital is equal to Capital employed less than other non-operating assets like cash or cash equivalents.

Although both ROIC vs ROCE uses Net operating profit in the numerator, it is the denominator that differentiates the outcome. While ROCE is a broader measure, as it considers the total capital that is employed in the business, ROIC is a more direct approach for analyzing the profitability of the business, as it only considers the capital that is per se used in the business operations.

Consider the following example to understand the nitty-gritty of both measures.

Suppose there are two companies, A & B that are both generating 1 crore EBITDA. The revenue for both the companies is 5 crores, however company A had invested 50 crores to buy the place for manufacturing and equipment required to produce the product, whereas company B had invested only 10 crores for the same by buying the used equipment and leasing out the place for manufacturing.

Now if we compare the return that both the companies generated, relative to the capital invested, we can form an opinion on the profitability of both the companies.

Company A: 1/50 = 0.02 (2%)

Company B: 1/10 = 0.1 (10%)

Although both companies A & B generated the same EBITDA of 1 crore, Company B was able to generate a higher return of 10% on the invested capital, by making a smart decision of investing in a used place & equipment that brought down its overall cost.

Return on capital employed (ROCE)

The formula for calculating ROCE is as follows;

ROCE: Net operating profit/ Capital Employed

‘Net operating profit’ refers to the profit generated from the core operations of the business. In simple terms, it is derived by subtracting Revenue from selling & administrative expenses. The term ‘Capital’ refers to the capital sourced from both Equity & debt.

From the above explanation, it is evident to conclude that ROCE measures the return generated on the capital invested in the business.

Head to Head Comparison Between ROIC vs ROCE (Infographics)

Below is the top 5 difference between ROIC vs ROCE :

Key Differences between ROIC vs ROCE

Both ROIC vs ROCE are popular choices in the market; let us discuss some of the major Difference Between ROIC vs ROCE :

• ROCE gives a broader picture of the profitability of any business, whereas ROIC represents a more granular picture of the return company generated relative the capital invested.
• ROCE includes the total capital employed in the business (Debt & equity) while calculating the profitability. On the other hand, ROIC only considers the capital that is actively utilized in the business.
• ROCE is a pre-tax measure, whereas ROIC is an after-tax measure.
• When calculating ROCE, a company is said to be profitable if it exceeds the cost of capital. On the other hand, if the ROIC is greater than zero, the company is said to be profitable. A negative number indicates the company is not efficient in capital management.

ROIC vs ROCE Comparison Table

Below is the topmost Comparison between ROIC vs ROCE :

Conclusion

The uncertainty of stock markets and misleading guidance of the companies expose the investors to a greater amount of risk of loss. Therefore, it is in the right interest of the investors that they evaluate the financial statements of the business before taking the investment decision.

The financial health of the company cannot be evaluated perfectly by looking at the numbers in isolation. Therefore, profitability ratios serve as an effective tool to evaluate financial statements on a relative basis. Both ROIC vs ROCE give the outcome by calculating the operating profit relative to how much capital the company invested. This makes it easier for investors to form an opinion on the management and profitability of the business. Investors can also compare these ratios with that of other companies so that decisions can be taken more effectively. If the company’s ROIC vs ROCE has been showing consistent growth, it indicates the capital of the business is rightly invested.

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