ROCE is a metric that measures the profitability of a company. Options available to a company seeking to improve on its return on capital employed (ROCE) ratio include reducing costs, increasing sales, and paying off debt or restructuring financing. Analysts use it to learn how efficiently a company employs its available capital. ROCE is calculated in the following manner:
Return on capital employed = Capital used EBIT where: EBIT= Earnings before interest and taxes
Because it is a measurement of profitability, a company can improve its ROCE through the same processes that it undertakes to improve its overall profitability. The most obvious place to start is by reducing costs or increasing sales. Monitoring areas that may be racking up excessive or inefficient costs is an important part of operational efficiency.
A key area to overall operational inefficiency that may be improved upon is inventory management. Proper inventory management can often be a very effective means of improving a company's overall financial performance. Proper monitoring, organization, and coordination of ordering inventory can significantly improve a company's cash flow and available working capital. This allows the company to reinvest more capital back into the company on a regular basis, which enables it to grow and increase its market base.
ROCE is a useful metric of financial performance and has been shown to be particularly helpful in comparisons between companies engaged in capital-intensive industry sectors. It has gained a strong reputation as a benchmark financial tool for evaluating oil and gas companies. However, no performance metric is perfect, and ROCE is most effectively used with other measures, such as return on equity (ROE). ROCE is not the best evaluation for companies with large, unused cash reserves. ROCE accounts for debt and additional liabilities, unlike other profitability ratios such as the return on equity (ROE) ratio. Analysts and investors use the ROCE ratio in conjunction with the ROE ratio to get a more well-rounded idea of how well a company can generate profit from the capital it has available.
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