Investing News

ROCE vs. ROA: What’s the Difference?

4 weeks ago
20 Views
3 Min Read
Reviewed by Margaret JamesFact checked by David RubinReviewed by Margaret JamesFact checked by David Rubin

Return on Capital Employed (ROCE) vs. Return on Assets (ROA): an Overview

Return on capital employed (ROCE) and return on assets (ROA) are two similar profitability ratios investors and analysts use to evaluate companies. The ROCE ratio is a metric that evaluates how efficiently a company’s available capital is utilized.

Key Takeaways

  • Return on capital employed (ROCE) and return on assets (ROA) are profitability ratios.
  • ROCE is similar to return on equity (ROE), except it includes debt liabilities, where a higher ratio means a company is making good use of its available capital.
  • ROCE is best used to compare companies in capital-intensive sectors—i.e., those companies that carry a lot of debt.
  • Return on assets (ROA), unlike ROCE, focuses on the efficient use of assets.
  • These profitability ratios are best used to compare similar companies in the same industry.

Return on Capital Employed (ROCE)

The formula to calculate ROCE is as follows:

ROCE=EBITCapital Employedwhere:EBIT=Earnings before interest and taxbegin{aligned} &text{ROCE} = frac{text{EBIT}}{text{Capital Employed}}\ &textbf{where:}\ &text{EBIT} = text{Earnings before interest and tax} end{aligned}

​ROCE=Capital EmployedEBIT​where:EBIT=Earnings before interest and tax​

Capital employed is defined as total assets minus current liabilities or total shareholders’ equity plus debt liabilities. Therefore, it is similar to the return on equity (ROE) ratio, except it also includes debt liabilities.

The higher the return on capital employed, the more efficiently a company makes use of its available capital to generate profits. The ROCE ratio is especially useful for comparing similar capital-intensive companies. A good ROCE ratio for a company should always be higher than its average financing interest rate.

ROCE is best used when comparing companies in capital-intensive sectors, such as utilities and telecoms, because, unlike other fundamentals, ROCE considers debt and other liabilities as well. The ROCE is useful for comparing companies with significant debt.

ROCE may need adjustments, including subtracting cash from capital employed, to get a more accurate measure for comparison. The long-term ROCE is important, where investors favor companies with stable and rising ROCE numbers.

Return on Assets (ROA)

The return on assets is similar to the ROCE ratio in that it measures profitability and financial efficiency. The difference is that the ROA ratio focuses specifically on the efficient use of assets.

The ROA ratio divides annual earnings by total assets to indicate how much revenue per dollar is generated in relation to the company’s assets. It is calculated using the following equation:

ROA=Net IncomeTotal Assetstext{ROA} = frac{text{Net Income}}{text{Total Assets}}

ROA=Total AssetsNet Income​

A high value of the ROA ratio is a strong indication a company is functioning well, making significant returns from assets. As with other profitability ratios, the ROA is best used to compare similar companies in the same industry.

Key Differences

The differences between the ROCE and ROA ratios are not many, but they are significant. Different profitability ratios exist precisely to enable investors and analysts to evaluate a company’s operational efficiency from various perspectives to obtain a fuller picture of a company’s true value, financial condition, and growth prospects.

Read the original article on Investopedia.

Newsletter