Return on equity (ROE) and return on capital employed (ROCE) are both profitability ratios that are often used together to analyse the overall financial performance of a particular company.
The ROE highlights what a company is generating on a net basis for its shareholders (equity) and is calculated by dividing the net income by total equity.
Similarly, ROCE as a financial metric is used to assess the efficiency of a company in utilising its capital with regard to generating profits.
ROCE is calculated by dividing the earnings before interest and taxes (EBIT) by the capital employed, which is the sum of fixed assets such as factories, machines, buildings, etc and working capital relates to inventories, accounts receivable, etc.
Generally, the higher the value of the ROCE ratio, the better the chances of generating profits.
While both ratios are used for understanding the operational efficiency of a company and the resulting potential for future growth in terms of value, there are certain key differences, however.
ROE assesses the efficiency of using and managing equities by a particular company. At the same time, ROCE highlights how efficiently the employed capital is being used and managed by a company.
From the investor’s perspective, ROE is a significant ratio as it focuses on equity. However, ROCE is a significant ratio from a company’s point of view as it focuses on the total capital employed both debt and equity.
In fact, the best way to evaluate a particular company’s financial performance is to look at the ROE and the ROCE in a combined manner.
In case the ROCE value is higher as compared to the ROE value, it translates that the company is efficiently utilising its debts to lessen the cost of capital. A higher ROCE essentially highlights that the company is generating higher returns for the debt holders as compared to the equity holders.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.
