Introduction:

Investing in shares of companies allows you to gain excellent returns in the long term. However, before you put your hard-earned money into a company, it is crucial to ensure that it is fundamentally sound and stable. Hence, you must conduct a fundamental analysis.

Fundamental analysis involves a thorough evaluation of various financial metrics of a company. For example, you can analyze different ratios, particularly profitability ratios, to gauge a company’s financial strength before investing in its shares. Return on Capital Employed (ROCE) and Return on Invested Capital (ROIC) are the most popular profitability ratios.

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In this article, we will discuss in detail the ROCE and ROIC and the differences between them. Continue reading.

What is ROCE?

As mentioned above, ROCE stands for Return on Capital Employed. It is a profitability ratio used to determine the profit a business can make through the total capital it has employed to date. You can calculate the ROCE of a company by dividing its Earnings Before Interest and Tax (EBIT) by the total capital it has employed till the current date.

So, the formula to calculate the ROCE is as follows:

ROCE = Earnings before interest and tax / Total capital employed

The total capital employed by a company can be calculated by subtracting its current liabilities from the value of its total assets.

A high ROCE indicates that a company is highly efficient in using its capital to generate profits. Thus, investing in shares of companies with consistently increasing ROCEs can be an attractive option for investors like you.

What is ROIC?

ROIC stands for Return on Invested Capital. It's another popular profitability ratio that measures how well a company uses its invested capital to generate profits. As an investor, you can use the ROIC of a company to determine estimated returns you can generate by investing in it. You can calculate the ROIC of a company by dividing its net profit after tax by the total capital it has invested to date.

The formula for calculating ROIC is as follows:

ROIC = Net profit after tax / Total capital invested

The total capital invested by a company can be calculated by subtracting its current liabilities and cash in hand from the sum of tangible and intangible assets.

Like ROCE, a high ROIC also indicates a company is highly efficient in using its investors’ capital to generate profits. So, investing in a company with constantly increasing ROIC can fetch you good returns in the long term.

Differences between ROCE and ROIC

While both ROCE and ROIC are used to determine a company’s efficiency in generating profits from the available capital, there are some considerable differences between the two terms. The table below depicts the differences between ROCE and ROIC:

To conclude

As you can see, both ROCE and ROIC are crucial profitability ratios that can be used to determine a company’s fundamental strength and efficiency. They can also help you understand if a company can utilize its capital effectively to provide decent returns to its investors. Knowing the differences between the two can help you decide which ratio is more useful for making investment decisions.

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