Return on Capital Employed (ROCE)

What is ROCE?

Return on Capital Employed (ROCE) tells us:

“How much profit the business earns from every RM1 of long-term capital invested.”

It measures overall profitability and efficiency of the business, using both equity and long-term debt.

Use it to compare:

• This year vs last year (trend), and
• One company vs another in the same industry.

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2. Formula for ROCE

The common exam-friendly version:

$$\textbf{ROCE} = \frac{\text{Profit before interest and tax (PBIT)}}{\text{Capital employed}} \times 100\%$$

Where:

• PBIT = Operating profit (before finance cost and tax).
• Capital employed =
  • Either Total assets − Current liabilities, or
  • Equity + Non-current (long-term) liabilities.

Both are acceptable if you are consistent.

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3. Step-by-step to calculate

1. Find PBIT in the income statement
   • Sometimes called “profit before interest and tax” or “operating profit”.

2. Calculate capital employed at year-end:

   • Option A:

     $$\text{Capital employed} = \text{Total assets} - \text{Current liabilities}$$

   • Option B:

     $$\text{Capital employed} = \text{Equity} + \text{Non-current liabilities}$$

3. Plug into the formula:

$$\text{ROCE} = \frac{\text{PBIT}}{\text{Capital employed}} \times 100\%$$

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4. How to interpret ROCE

• Higher ROCE = better use of capital.
• Example meaning:

  • ROCE = 12% → “The business earns 12 sen profit before interest and tax for every RM1 invested in long-term capital.”

Use ROCE to check:

1. Trend over time

   • Rising ROCE → performance improving
   • Falling ROCE → performance getting weaker
2. Compare with competitors / industry
   • If company’s ROCE is higher than industry average, it is usually more efficient.
3. Compare with cost of capital (interest rate / required return)
   • If ROCE < cost of borrowing → the company may be destroying value.

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5. What is a “good” ROCE?

There is no fixed magic number, but in simple terms:

• ROCE should be higher than the cost of debt (interest rate)
• And “reasonable” compared to similar companies
• Many stable businesses aim for double-digit ROCE (e.g. >10%) – but exam answers should always say “compare with industry / past years”, not just “good or bad” blindly.

Exam phrase you can use:

“ROCE of 15% is considered satisfactory if it exceeds the company’s cost of capital and is higher than previous years and the industry average.”

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6. Simple numeric example

Given:

• Profit before interest and tax (PBIT) = RM300,000
• Equity = RM800,000
• Non-current liabilities = RM400,000

Step 1 – Capital employed:

$$\text{Capital employed} = 800,000 + 400,000 = 1,200,000$$

Step 2 – ROCE:

$$\text{ROCE} = \frac{300,000}{1,200,000} \times 100\% = 25\%$$

Interpretation:

“The company earns 25 sen of operating profit for every RM1 invested in long-term capital – this suggests strong overall profitability.”

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7. Limitations of ROCE (short exam points)

You can also remind students:

1. Based on historical costs – assets shown at old prices → can distort ROCE.
2. Influenced by accounting policies – depreciation method, revaluation, etc.
3. One ratio alone is not enough – must be read together with other ratios (margin, asset turnover, gearing, liquidity).

In Summary:

“ROCE is a useful overall measure of performance, but it must be interpreted together with other ratios and with knowledge of the company’s accounting policies.”