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Sustainability of Business-ROCE(Return on Capital Employed) & new
ROCE(Return on Climate & Environment)-an Integrated approach
ROCE(Return on Capital Employed), according to Warren Buffet, is an
important Financial Ratio that is used for measuring the combined effect of
Profitability of the Business and the Productivity of the Business assets which
can sustain its value.
Profitability is measured in terms of Return on Sales and
Productivity is measured in terms of how well the Assets of the Business are
put to use by looking at Assets Turnover.
(1)The formula used for calculating Return on sales is PBIT less Tax/Net
Sales.
(2)The formula for calculating Turnover on Assets is Net Sales/(Net
Fixed Assets+Net Current Assets i.e(Current Assets-Current Liabilities)
(3) the formula for calculating Return on Capital Employed(ROCE) is
obtained by Multiplying (1)X(2)- (calculated for every year separately in the
example given below)
The following is a real example of a trend of ROCE of a Business over
the years ,that has three Verticals:
Belts, Oilseals and Engineering.The composite business is called
Polymer.
Now for this Business ,an analysis is done and the ways of how to
improve the ROCE of this Business have been identified. This is as follows:
How to
Improve ROCE of the Business
This ROCE improvement
Plan can be built through Balanced Scorecard Methodology.(The Balanced
Scorecard;Measures that drive Performance-HBR-1992 by Dr.Robert S.Kaplan and
David P.Norton )
EVA Ratio-"Economic Value Added"(Stern Value Management) of
the Business, which is the Economic Profit of the Business can also be
considered as the Ultimate Financial goal of a Business . The EVA is NOPAT(Net
Operating Profit After Tax)- (Invested Capital*WACC) where Invested Capital
includes both Equity & Debt and WACC is Weighted Average Cost of Invested
Capital. In this WACC, the cost of Debt i.e Borrowed capital is calculated Net
of Taxes, where the local Income/Corporate Tax policies allow deduction for the
Interest paid on Borrowed Capital and the Dividend payable/expected by
Shareholders is considered as the Cost of Equity.When EVA is integrated with
Value-Based Management that becomes the key to Sustainable Value Creation by
any Organisation(Stern Value Management-1993- “The Real key to Creating
Wealth”).
A sample of Strategy Map developed with EVA &ROCE Ratios being
tracked on Quarterly basis by comparing Actuals vs Target ,under Balanced
Scorecard Methodology for a Co. in India is given below:
The benefits of drawing out a Strategy Map like
this on Financial perspective built on Financial Ratios at the pinnacle, and
Customer ,Operational and Learning & Growth perspectives are many due to
interplay of cross-functional interactions and improvements flowing through the
entire organisation. When this happens the organisation functions as a one
whole being with all its parts working in Sync, Synergistic & Sustainable
ways.
On an external environment, it is like all the
players of a Team planning a carefully laid out Strategy in a tournament for
winning a World cup in Soccer or Cricket!!
Since, the world has already moved into Sustainable
Business models with 3Ps as the focus-Profit, People and Planet, and is now
rapidly moving into Sustainable business through harmonious assimilation of
Environment,Social and Governance values into Business Sustainability(The
Investor Revolution-HBR-May-june 2019 bySvetlena Klimenko and Robert G.Eccles).
Now, we have reached a point where we need to
integrate traditional ROCE-Return on Capital Employed with the new Return on
Climate and Environment.ESG reporting in
India started in 2009 with the Ministry of Corporate Affairs (MCA) issuing the
Voluntary Guidelines on Corporate Social Responsibility, since then the
reporting landscape has come a long way with the introduction of Business
Responsibility Reporting (BRR), Corporate Social Responsibility (CSR), IR,
National Guidelines on Responsible Business Conduct (NGRBC) and the newly
introduced Business Responsibility and Sustainability Report (BRSR) (introduced
through a SEBI circular dated 10th May 2021).
World Economic forum on its part has come out with set
of 21 core and 34 widened metrics and disclosures in its report “Measuring
Stakeholder Capitalism:Towards Common Metrics and Consistent Rporting of
Sustainable Value Creation “(WEF report,2020), as an extension of Stakeholder
Capitalism Metrics standing on 4 pillars-People,Planet,Prosperity and
Principles of Governance.
For future growth of the Sustainable Business Value
Creation the integration of these metrics with Financial Metrics, is
sine-qua-non.
