ROCE-Return on Capital Employed- a fair measure Ratio to know the Business Efficiency in Nutshell

ROCE(Return on Capital Employed)_A Ratio analysis

ROCE is an important Financial Ratio that is used for measuring the combined effect of Profitability of the Business and the Productivity of the Business. 

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 Return on Assets is Net Sales/(Net Fixed Assets+Net Current Assets)

(3) the formula for calculating Return on Capital Employed(ROCE) is obtained by Multiplying (1)X(2)-(calculated for each 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.

EVA Ratio-"Economic Value Add" 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.

A sample of Strategy Map developed  with EVA &ROCE Ratios ,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 & Synergy.

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!!