ROCE explained: return on capital employed and how to improve it

The formula

ROCE equals operating profit divided by capital employed, expressed as a percentage. Capital employed is total assets minus current liabilities, which is the long-term funding actually working in the business.

Why investors favour it

ROCE is capital-structure neutral at the numerator: it uses operating profit before interest, so a highly geared business cannot flatter the measure by shifting costs below the operating line. It answers one question: for every unit of long-term capital in this business, how much operating profit comes back each year.

What counts as good

There is no universal threshold. The honest test is whether ROCE exceeds the cost of capital. A return of 12 percent against a 9 percent cost of capital creates value. A return of 6 percent destroys it, however large the profit looks in absolute terms.

Getting capital employed right

• Use closing balances consistently, or an average of opening and closing if the asset base moved sharply.
• Exclude surplus cash only if you disclose the adjustment.
• Keep leases on the balance sheet where the standard requires it, otherwise ROCE is overstated.
• Do not net off overdrafts against cash unless the right of set-off is real.

Three levers that move ROCE

1. **Margin** — raise operating profit on the same revenue by pricing or cost control.
2. **Asset efficiency** — same profit from a smaller asset base, usually by clearing slow inventory and shortening receivable days.
3. **Capital discipline** — retire assets that earn less than the cost of capital instead of carrying them.

Common mistakes

Using net profit instead of operating profit mixes financing into a return measure. Comparing ROCE across industries without adjusting for asset intensity is meaningless. And computing ROCE without a real balance sheet, from bank data alone, is not possible.

NanoFora calculates ROCE from the posted ledger and shows the operating profit and capital employed behind the percentage. See also financial ratio analysis and the working capital calculator.