ROIC vs ROCE: Decoding the difference between key performance ratios
Which one is a superior metric? Let us find out.
Return on Invested Capital (ROIC) and ROCE (Return on Capital Employed) are financial ratios to understand how efficiently a company invests its capital.
ROIC gives a metric to find out how well a company is using its capital to generate profits. It is the money a company makes over and above its average cost of capital(Debt + Equity).
ROIC = EBIT Less Actual Taxes
Operating Assets – Operating Liabilities
ROIC is a return to both equity and debt holders. It is a better measure of profitability than ROE as it allows comparison across companies with different capital structures and tax rates. Companies with high ROIC can be viewed as those with a competitive advantage.
ROCE= Operating Profit
Debt + Equity
ROCE is suitable for the comparison of companies with different tax rates.
ROCE Example
Consider two companies from the same industry: ABC Ltd and XYZ Ltd. The table of financial information of the two companies is below.
|
(in Rs lakh)
|
ABC Ltd.
|
XYZ Ltd.
|
|
|
Sales
|
12000
|
60,000
|
|
|
EBIT
|
3,000
|
12,600
|
|
|
Debt
|
5,000
|
25,000
|
|
|
Equity
|
5,000
|
38,000
|
|
|
Capital Employed
|
10,000
|
63,000
|
|
|
ROCE
|
30%
|
20%
|
|
|
|
|
|
|
It can be noticed that XYZ Ltd is a bigger corporate with 5x sales, 4.2x EBIT and a bigger capital base but on using the ROCE metric, it is seen that ABC Ltd is more efficiently generating profit from its capital than XYZ Ltd with respective ROCE at 30 per cent (ABC) and 20 per cent(XYZ Ltd).
Both ROIC and ROCE can be used to examine profitability efficiency in terms of capital. Both have a similar numerator, which is Operating Profit. But the difference arises in the denominator, while ROIC uses invested capital ROCE uses the total capital the company has.
Another key difference between ROIC and ROCE is that ROCE is based on pre-tax figures while ROIC is based on after-tax figures.
Both indicators are comparable in that they give an indication of profitability relative to the firm's total capital. In general, for a corporation to remain profitable over the long run, both the ROIC and ROCE should be higher than the weighted average cost of capital (WACC).