Return on Average Capital Employed

The return on average capital employed (ROACE) is a ratio that reveals the profitability against the investments made in the company. The return on average capital employed is different from the return on capital employed for it counts the average of the opening and closing capital for the specific period contrasting to only the capital figure at the end of a period.

The return on average capital employed is helpful for analyzing businesses in capital-intensive industries, oil & gas or mining for example. The businesses capable of squeezing higher profits from a smaller amount of capital assets will feature a higher return on average capital employed as compared to those which are not efficient in transforming capital into profits.

Formula used for computing return on average capital employed

The return on average capital employed is calculated as:

ROACE = EBIT / (Average Total Assets – Average Current Liabilities)

i.e. Capital Employed = Total Assets – Current Liabilities = Equity + Non-current Liabilities

 


This ratio is used to compare the performance of entities ignoring the way of financing. The return on average capital employed is the combined return to owners of an entity and the holders of debt instruments (issued bonds and long-term financing by banks and other institutions (not being owners). It provides a more easily to use comparison basis to analyse the capability of an entity to manage its net business assets. This is also because there are entity using little equity and more debt (building and construction industry) versus more equity and little debt (oil & gas industry). More and little are relative in contrast, not absolute!

See how it works:

Balfour Beatty

Accounts 2018 – Building & Construction

Shell

Financial statements 2018 – Oil & Gas

Unilever

Accounts 2018 – Consumer goods

GBP million

USD million

EUR million

Total revenue

6,634

388,379

50,982

Earnings before interest and tax

147

35,295

12,842

EBIT in total revenue

2.2%

9.1%

25.2%

2018

2017

2018

2017

2018

2017

Total assets

4,567

4,877

399,194

407,097

59,456

60,285

Current liabilities

2,124

2,567

118,847

129,518

19,772

23,177

Capital employed

2,443

2,310

280,347

277,579

39,684

37,108

Average capital employed

2,377

278,963

38,396

Return on average capital employed

6.2%

13.9%

33.5%

Return on average equity

11.7%

6.0%

75.5%

This shows the attractiveness of entities operating in Consumer goods, high margins, low equity provides a superior return on average capital employed and return on average equity (ROAE), the difference shows between Oil & Gas and Building % Construction, return on average capital employed is low for Building % Construction but the return on average equity is higher than in Oil & Gas.

This shows the benefits in using ratios.

A ratio in itself is not interesting, comparing it over time for one entity is a starting point for asking the right questions,

using a select choice of ratios and different companies/industries/sizes provides the starting point of a

thorough analysis and lots of the right questions

!!

Return on Average Capital Employed

Return on Average Capital Employed

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