Using ratios to analyse companies

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6. Return on capital employed (ROCE)

Definition: Operating profit as a percentage of total capital employed.

Significance:

ROCE takes all the assets employed in the business including borrowings and measures the annual return the company made on them. If a company has a low ROCE, it is using its resources inefficiently, even if its profit margin is high.

Calculation:

Multiply operating profit by 100, and divide the result by total capital employed.

Example

ROCE calculator Operating profit £  m Total capital employed £  m ROCE       %

Yardstick:

A company's ROCE should be higher than the return on gilts (the benchmark for a risk-free investment return). And unless it is higher than the cost of borrowing, any increase in the company's borrowings or the general level of interest rates will reduce shareholders' earnings.

1. Why bother with ratios? 2. A word of warning 3. The P&L and the balance sheet 4. Grouping the ratios 5. Profit margin 6. Return on capital employed (ROCE) 7. Sales as a multiple of capital employed 8. Stockturn 9. Debt collection 10. Payment of trade creditors 11. Cash-to-cash cycle 12. Gearing 13. Interest cover 14. Current ratio 15. Quick ratio (acid test) 16. Earnings ratios 17. Dividend ratios 18. Other ratios 19. Sources of information 20. Conclusion

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