Return on capital employed is used to determine how much profit the company is able to generate on the capital employed by it. The capital employed is calculated by deducting current liabilities from its total assets.
How to interpret ROCE
This ratio indicates efficiency of a company in employing its capital and is also used to compare profitability levels between various companies. Higher ROCE indicates that a company is more efficiently using its capital and vice-versa. ROCE has to be higher than company’s cost of borrowing. This also helps companies decide if they should take on more debt for expansion projects.
Formula
ROCE = Earnings Before Interest Tax / (Total Assets – Current Liabilities)Company A Company BEBIT of Rs 200 crore EBIT of Rs 300 croreCapital Employed Rs 400 crore Capital Employed Rs 1200 croreROCE 50% (200/400)% ROCE 25% (300/1200)%Company A is efficiently using its capital than company B.Return on Equity (ROE) or Return on Net Worth
Return on Equity reveals how much profit a company generates with the money that equity share holders have invested. It will show the investors how well their capital is being reinvested by the company.
How to interpret ROE
A higher ROE suggests that a company is able to effectively generate cash internally. This ratio is useful for comparing the profitability of a company to that of other firms in the same industry. The better way is to compare a company’s ROE with its industry average.
Company A | Company B |
Net Income Rs 200 crore | Net Income Rs 300 crore |
Equity Rs 400 crore | Equity Rs 1200 crore |
RONW 50% (200/400)% | RONW 25% (300/1200)% |
Company A generated 50 percent returns in the form of earnings for every rupee invested by shareholders. Company B generated lower returns for its shareholders compared to company A.
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