Return on Average Capital Employed

Last update 04/01/2020

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