Investment Guide

What is the Return on Capital Employed (ROCE)?

By admin
19 September 2025
7 mins read

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What is the Return on Capital Employed (ROCE)?

Return on Capital Employed (ROCE) is an important financial ratio used to analyze the profitability and capital efficiency of a firm.

To provide a comprehensive picture of the company’s financial performance, ROCE considers both debt and equity. A high and consistent ROCE shows that the business is doing a good job of managing its capital.

This article explores the return on capital employed meaning, how to calculate it, and why it matters.

What is ROCE?

Return on capital employed (ROCE) is a financial ratio that measures how efficiently a company uses its capital. It shows the ability of the enterprise to generate returns on the total capital invested, which includes equity as well as debt but excludes short-term debt.

Investors use ROCE to assess the capital efficiency of the management, compare the performances of different companies, and identify investment opportunities with high return potential. A high ROCE indicates that the company is able to generate high returns on its investment and carries superior growth potential.

Return on Capital Employed ratio calculation with formula

The formula for calculating the Return on Capital Employed ratio is as follows:

ROCE = EBIT / Capital Employed,

wherein

EBIT = Earnings Before Interest and Tax; the company’s total profits before deducting any interest or tax payments

Capital Employed = Total amount of capital invested - Current liabilities

Let’s use the ROCE ratio formula in the following example for a better understanding.

Suppose the EBIT of XYZ Ltd. is Rs. 200 crores. This is the profit it earns before paying any interest or taxes. The total assets are worth Rs. 600 crores, and the current liabilities are worth Rs. 200 crores.

Before calculating the ROCE, let’s calculate the capital employed using the above formula.

Capital Employed = Total amount of capital invested - Current liabilities

Capital Employed = Rs. 600 crores - Rs. 200 crores = Rs. 400 crores

Now, ROCE = EBIT / Capital Employed (Rs. 200 crores / Rs. 400 crores)

ROCE = 0.5 or 50%

Thus, XYZ Ltd. earns a return of Rs. 50 for every Rs. 100 spent. In simpler words, the company earns a 50% profit.

How to use ROCE with an example?

Let’s take the example of two companies to understand ROCE analysis:

Aspect	Maree Industries (in ₹ crores)	Prestige Ltd. (in ₹ crores)
Sales	5,200	18,000
EBIT (Operating Profit)	1,300	2,700
Total Assets	4,800	20,500
Current Liabilities	900	5,000
Capital Employed	3,900	15,500
ROCE (EBIT/Capital Employed)	33.33%	17.42%

Although Prestige Ltd. is a bigger company with higher sales and profits, Maree Industries generates more return on each rupee of capital employed. In this example, Maree Industries earns Rs. 0.33 (33.33%) for every ₹ 1 of capital employed, while Prestige Ltd. earns only Rs. 0.17 (17.42%).

Importance of ROCE

ROCE shows how well a company utilizes its capital to generate profits, offering insights into operational effectiveness.
It allows investors to compare the performance of companies within the same industry, highlighting those with better capital efficiency.
A consistently high ROCE suggests that a business is capable of sustaining long-term returns on its investments.
Businesses use ROCE to evaluate the profitability of various projects or investments, ensuring optimal capital allocation.
A higher ROCE signals financial health and efficiency, making the company appealing to potential investors.

Pros and cons of ROCE

After learning what is return on capital employed, let us look at the pros and cons of ROCE.

Importance	Limitations
It shows how well a company uses its capital to generate returns.	Not ideal for comparing different industries.
It is a better measure of a company’s financial performance than ROE, as it includes debt and equity.	Lower ROCE with large cash reserves can be misleading.
Good for comparing companies in the same industry.	Older companies might have higher ROCE due to asset depreciation.
Higher ROCE indicates a high efficiency in utilizing the capital to generate profits.	Can change yearly, considering trends over time.
Useful for investors and companies to evaluate performance.	It should be used with other measures for a full picture.

What is the difference between ROCE & ROIC?

Factor	ROCE	ROIC
Formula	EBIT / Capital Employed	NOPAT / Invested Capital
Considers Tax?	No	Yes (includes tax-adjusted profit)
Capital Definition	Total Assets - Current Liabilities	Net Working Capital + Fixed Assets + Goodwill / Intangibles
Profit Definition	EBIT (Earnings Before Interest & Tax)	NOPAT (EBIT × (1 –-Tax Rate))
When to Use	For high-level comparisons between firms or sectors	For detailed profitability analysis, including tax impact

With a clear understanding of what is ROCE and what is ROIC, you can make a better judgment on the performance of a company and sectors.

What are the key factors affecting ROCE in the share market?

Various factors affect ROCE in the share market. However, before exploring the key factors, let’s briefly understand what is ROCE in the share market and its use for investors.

What is ROCE in the stock market?

ROCE is a vital metric used in the stock market to understand if a company is using its capital efficiently and its ability to generate profits. It helps investors determine whether or not the company is worth investing in.

The factors affecting ROCE are:

1. Profitability

A company with higher profitability has a better ROCE than a company with lower profitability. Profitability is based on a company’s allocation of money into fixed and variable expenses, efficiency in operations, and pricing power. If a company can manage its costs while optimizing its operations, its ROCE is high.

2. Financial leverage

ROCE is also affected by the level of financial leverage. Debt financing is a cost-effective approach and can increase returns on equity, resulting in a higher ROCE. But excessive leverage can also increase risk if its management is poor.

3. Capital intensity

Capital intensity affects ROCE indirectly. So, ROCE is lower if a company’s fixed assets are significant because a higher capital base negatively impacts returns. To achieve a favorable ROCE, a company must use its capital efficiently.

4. Economic conditions

Economic conditions also have a significant impact on ROCE. When the economy faces a downturn or recession, the demand reduces, and costs increase for companies. As a result, ROCE falls. On the other hand, when economic conditions are favorable, ROCE increases as costs reduce and profitability increases.

How to improve ROCE?

A company requires a strategic approach focused on enhancing profitability and capital efficiency to improve ROCE. Here are the different ways you can achieve this goal:

1. Enhance operational efficiency

Simplify processes to lower costs and boost productivity.
Adopt automation and process improvements to reduce waste and improve profitability.

2. Optimize capital allocation

Analyze and make capital investment decisions based on return potential.
Align investments with long-term strategic goals for sustainable growth.

3. Strengthen working capital management

Reduce excess inventory to bring carrying costs to a minimum.
Reduce receivables collection timeframe to improve liquidity.
Manage payments efficiently to manage cash flow.

4. Maximize asset utilization

Renegotiate leases and contracts to get better terms and higher returns.
Discard non-performing or underutilized assets.
Opt for shared asset models to reduce capital expenditure.

5. Minimize excess capital usage

Avoid unnecessary long-term investments with low returns.
Focus on projects with quicker payments and higher profitability.

6. Improve pricing and margins

Review pricing strategies regularly to reflect market conditions.
Develop innovative products and services to command premium pricing.
Strengthen customer relationships to expand market share and revenue.

7. Focus on talent and risk management

Train employees to enhance skills, efficiency, and innovation.
Reduce risks to avoid financial or operational disturbances.

8. Continuous monitoring and evaluation

Track progress against defined ROCE targets.
Identify underperforming areas and refine strategies accordingly.
Ensure strategies are tailored to industry, competition, and internal capabilities.

Limitations of ROCE

The Return on Capital Employed (ROCE) ratio has many applications. However, like other accounting measures, it has limitations, too.

ROCE helps to effectively compare the financial performances of two companies in the same sector. However, the drawback lies in comparing firms belonging to different sectors, as it cannot provide sufficient data.
ROCE gives insight into the company’s capital utilization. However, assessing a single metric of performance isn’t quite effective. You must study other financial measures with ROCE to make more informed investment decisions.
The ROCE for companies with an underutilized cash reserve will be low, which can affect the actual result and overall choice. The ratio isn’t the best choice for evaluating the performance of businesses with significant untapped cash reserves.
The calculation of Return on Capital Employed (ROCE) is based on the company’s annual market performance. It cannot remain constant and varies from year to year. Thus, you must assess ROCE changes over time before comparing different firms.

FAQs

What does it mean for capital to be employed?

Capital employed refers to the total amount of capital a business uses to run its operations and generate profits. It is calculated using this formula: Capital Employed = Total Assets - Current Liabilities.

What does it imply to say that capital is being used?

Capital being used refers to how a company employs its financial resources—equity and debt—for operational activities, investments, and profit generation. Efficient use of capital ensures higher returns and sustainable growth.

How is ROCE calculated?

ROCE is calculated using the formula:

ROCE = Earnings Before Interest and Tax (EBIT)/Capital Employed, where capital employed is total assets minus current liabilities.

What constitutes a good ROCE value?

A ROCE value of at least 20% is considered good. Generally, higher ROCE indicates effective capital utilisation and profitability, but benchmarks can vary by sector.

Why is ROCE important when we also have ROE and ROA metrics?

ROCE considers both equity and debt, providing a holistic view of profitability compared to ROE, which focuses on equity, and ROA, which focuses on total assets. It is a key metric for understanding how efficiently overall capital is utilized.

Why is ROCE useful if there are already ROE and ROA measures?

ROCE is important because it gives a more complete picture of a company’s profitability, especially when compared to Return on Equity (ROE) and Return on Assets (ROA).

Is 10% a good ROCE?

It depends on the industry average and the company’s cost of capital. A 10% ROCE may be acceptable in stable and low-risk industries. However, in growing sectors with low capital costs, a 10% ROCE isn’t very attractive. Investors generally prefer a ROCE of at least 20% for such sectors.

What is ROI vs ROE vs ROCE?

ROI stands for Return on Investment. It measures the overall profit from an investment. ROE stands for Return on Equity. It indicates how efficiently a company generates profit relative to shareholder’s equity. ROCE stands for Return on Capital Employed. It measures how efficiently a company uses its capital to generate profit.

Is a higher ROCE better?

Yes. A higher ROCE is generally considered better as it means that a company is using its capital efficiently to generate profits. In other words, it reflects strong financial performance and effective utilization of resources. However, you must consider industry standards and analyze other financial metrics before making an investment decision.

Who decides the repo rate?

The Central Bank of the country decides the repo rate. In India, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) determines the repo rate after reviewing key macroeconomic indicators, such as inflation, liquidity, and economic growth. The MPC reviews the repo rate every two to three months.

What is the current reverse repo rate?

As of 30 August 2025, the current reverse repo rate in India is 3.35%. It was last changed in October 2020 by the RBI and has remained unchanged since then. The reverse repo rate is the interest rate at which the RBI borrows surplus funds from commercial banks.