Return on Capital Employed or Investment

Return on Capital Employed (ROCE), also called Return on Investment (ROI), is a profitability ratio that measures how efficiently a business uses its long-term funds to generate profit. It answers the question: for every rupee of long-term capital invested in the business, how much profit is earned before paying interest and tax?

The ratio focuses on the overall utilisation of funds — it looks at the business as a whole, not just the shareholders’ perspective. This makes it a key metric for all long-term suppliers of capital: shareholders, debenture-holders, and lenders.

What is Capital Employed?

Capital employed refers to the long-term funds used in the business. There are two common ways to calculate it:

• Method 1 (Sources side): Shareholders’ funds + Debentures + Long-term loans
• Method 2 (Assets side): Non-current assets + Working capital

What is Profit for this Ratio?

The profit figure used is Profit Before Interest and Tax (PBIT). This is also called Operating Profit or Earnings Before Interest and Tax (EBIT). Interest is not deducted because the return is being measured on total capital employed — which includes borrowed funds. Tax is excluded because it is not a cost of using capital; it is a distribution of profit to the government.

The Formula

The result is expressed as a percentage.

Significance

ROCE reveals the efficiency of the business in utilising the funds entrusted to it by shareholders, debenture-holders, and long-term lenders. A higher ratio indicates better use of capital.

• It is considered a good measure of profitability for inter-firm comparison, because it neutralises differences in capital structure (debt vs equity mix). …