ROIC vs ROCE

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Difference Between ROIC and ROCE

Return on Capital Employed (ROCE) is a measure that implies long-term profitability and is calculated by dividing earnings before interest and tax (EBIT) by capital employed, capital employed is the total assets of the company minus all the liabilities. In contrast, Return on Invested Capital (ROIC) measures the company's return on the total invested capital. It helps determine the efficiency in which the company is using the investor's funds to generate additional income.

ROIC VS ROCE

Return on Invested Capital (ROIC) and Return on Capital Employed (ROCE) come under profitability ratios that go beyond determining just the company's profitability. These ratios specifically examine how a company utilizes its capital to invest and grow further. ROIC, along with ROCE and other ratios, are helpful to analysts in assessing a company's financial condition and forecasting the future ability to generate profits.

 These ratios also help understand how the company is performing and help assess how much of profits are returned to investors.

These ratios help determine how efficiently the company uses the invested capital and are very similar and have few differences, mainly in the way these ratios are calculated.

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ROIC vs. ROCE Infographics

ROIC-vs-ROCE Infographics

Key Differences

  • The higher the ratios, the better for both ROCE and ROIC. It means that the company is better at utilizing capital. It indicates that the company is allocating capital in profitable investments.
  • These ratios are meaningful only when compared to WACC (weighted average cost of capital). If ROIC and ROCE are higher than WACC, then it is an indication that the company has generated value in the financial year.
  • If these ratios are lower than the cost of capital, it means that the company is in feeble financial health.
  • Even though calculating ROIC is conceptually straightforward, practical issues also have to be considered. For example, Invested capital does not consider intangible assets and the amount invested in human capital and goodwill. This investment helps in increasing the profits and is also reflected in cash flow; they are not reflected in ROIC.
  • The drawback of ROCE is that it measures return against book value rather than market value, which means as the assets are depreciated, ROCE will go on increasing even though the cash flows remain the same. It means that older businesses will have a high value compared to new ones, which may not necessarily be the case. Cash flow is also affected by inflation. It is also important to note that revenues will also increase with increasing inflation, while capital employed does not because the book value of assets is not affected by inflation.

ROIC vs. ROCE Comparative Table

ROICROCE
ROIC helps determine the efficiency of the total capital invested. It is a measure that helps determine if the company is allocating the capital in profitable investments.ROCE can be considered as a measure to inspect the efficiency of the companies business operations and measures the profits the company generates with the capital employed
ROIC Formula – Earnings before interest and tax (EBIT)*(1-tax rate) / Invested CapitalROCE Formula – (Earnings before interest and tax (EBIT) / Capital Employed). To be consistent, the numerator and denominator are taken before interest and tax.
Invested capital is a subset of capital employed and is the portion of the capital that is actively used in the business. Invested Capital can be calculated as = Fixed Assets + Intangible Assets + Current Assets – Current Liabilities – Cash.Capital employed in the denominator is calculated as (Debt + Equity – current liabilities). It implies all the capital that is part of the business.
This ratio is essential from the perspective of an Investor.This ratio is essential from the perspective of the Company.
Cross-sector comparisons using ROIC may not be meaningful. ROIC helps in assessing the company's performance within its sector. For example, it is comparing an energy company with IT. It compares the productivity of its operating assetsThe trend of ROCE is significant. ROCE looks at the company's long-term view and assesses the ability of the managers. It penalizes the management if ROCE holds too much cash for too long.

Conclusion

ROIC and ROCE are similar only with slight differences. These are vital ratios that help comparisons between companies and help in determining the company's graphs using the past year’s ratios. Both ratios can help compare companies that are capital intensive, for example – energy, telecommunication, and auto companies. These measures have limited use when it comes to service-based companies.