Return on Capital Employed (ROCE) vs. Retur🉐n on Assets (ROA): an Overview

Profitability ratios are used to determine whether companies can earn profits based on the information presented in their financial statements. Investors can use this information to make important decisions about their investments by comparing the ratios of different companies. Two of these ratios include return on capital employed (ROCE) and return on assets (ROA). The ROCE ratio is a metric that evaluates how efficiently a company’s available capital is utilized while the ROA measures a company's profitability relative to its assets.

Return on Capital Employed (ROCE)

Return on capital employed is just one profitability ratio that financial managers, stakeholders, and investors can use to make decisions about potential investment opportunities. This financial ratio assesses a company's profitability and capital efficiency. As such, investors and analysts can use it to determine how profitable a company is based on how well its working capital is used.

ROCE is expressed as a percentage and indicates the amount of profit a company generates for every $1 of capital it employs. Higher profits per dollar are better for the company and its investors. A company with a high ROCE means it has a high degree of profitability. A good ROCE ratio for a company should always be higher than its average financing interest rate.

This ratio is best used when 澳洲幸运5🎃官方开奖结果体彩网:comparing companies in capital-intensive sectors, such as utilities and telecoms, because, unlike o𓃲ther fundamentals, ROCE considers debt and other liabilities as well. The ROCE is useful for com🐽paring companies with significant debt.

ROCE may need adjustments, including subtracting cash from capital employed, to get a more acꦕcurate measure for comparison. The long-term ROCE is important, where investors favor companies with stable and rising ROCE numbers.

How to Calculate ROCE

The formula to calculate ROCE is as follows:

$\begin{aligned} &\text{ROCE} = \frac{\text{EBIT}}{\text{Capital Employed}}\\ &\textbf{where:}\\ &\text{EBIT} = \text{Earnings before interest and tax} \end{aligned}$​ROCE=Capital EmployedEBIT​where:EBIT=Earnings before interest and ꦺ;tax​

Capital employed is defined as total assets minus current liabilities or total 澳洲幸运5官方开奖结果体彩网:shareholders' equity plus debt liabilities. Therefore, it is similar to the 澳洲幸运5官方开奖结果体彩网:return on equity (ROE) ratio, except it also includes debt liabilities.

Return on Assets (ROA)

The return on assets measures the profitability and financial 澳洲幸运5官方开奖结果体彩网:efficiency of companies. The difference be🦄tween ROA and ROCE, though, is that the ROA ratio focuses on how profitable a company is relative to its assets. More specifically, this ratio determines whether a company can earn profits based on how efficiently it uses its assets.

ROA is commonly expressed as a percentage. A high ROA is a strong indication that a company is functioning well and making signꩲificant returns from assets. Conversely, a lower percentage could signal that the company is in trouble and needs to make improveme💜nts.

A return on asset ratio of over 5% is generally considered good while a ratio of 20% is deemed excellent. Having said that it's important to take this information with a grain of salt. That's because different industries report assets differently. For instance, there are fewer assets on the balance sheets of software companies, and they may be understated. This means that you may end up with slightly skewed results.

How to Calculate ROA

ROA can be ♚🤡calculated using the following equation:

$\text{ROA} = \frac{\text{Net Income}}{\text{Total Assets}}$ROA=Total AssetsNet Income​

The ROA ratio divides a company's net income (or its annual earnings) by total assets to indicate how much revenue per dollar is generated related to the company's assets.

Key Differences

The differences between the ROCE and ROA ratios are not many, but they are significant. Different profitability ratios exist precisely to enable investors and analysts to evaluate a company's 澳洲幸运5官方开奖结果体彩网:operational efficiency from various perspectives to obtain a fuller pic♛ture of a company's true value, financial cond🐓ition, and growth prospects.

We've highlighted some of the key differences between these two ratios in the table below.

The Bottom Line

Profitability ratios can help you make important decisions about your investments. Two of these are the return on capital employed and return on assets. While ROCE can tell you how well a company is using its capital, return on assets indicates a company's profitability based on the use of its assets. One thing to keep in mind is that you compare ratios of similar companies within the same sector. And be sure to make your decisions using different metrics so you get a better picture of how well your potential investors will fare.