Return on Capital Employed (ROCE) reveals how efficiently your business generates profit from invested capital.
Return on Capital Employed (ROCE) reveals how efficiently your business generates profit from invested capital.
Two companies could have the same story.
They do business in the same sector, report similar revenue, and operate on virtually the same margins.
So why is that other company generating genuine shareholder value while the other is quietly destroying it?
It's the trap of those surface-level profitability metrics
Net income ? Fine
EBITDA ? Respectable
Board meeting? Goes off without a hitch.
But digging under the surface, its easy to see that one of these companies is deploying their capital so haphazardly, so inefficiently, that every single dollar invested tends to return less than what investors could earn putting their money in a low-effort index fund.
Ouch.
And then, of course, there’s the big reveal: return on capital employed.
With return on capital employed, you get a sense of how well a company is using the money it’s invested.
It’s the question that all good investors, board members, and executives ought to be asking themselves:e we really making money with the money we’ve invested, or are we just spinning our wheels and calling it growth?
Most CFOs will be happy to tell you their EBITDA margins at a moment’s notice.
Not as many will be able to tell you, with any real accuracy, whether or not they’re beating the cost of the capital they’re using. It’s a problem, and one that often sneaks up on you over time.
This guide breaks ROCE down from formula to strategic application: what it measures, how to calculate it, where companies get it wrong, and how it connects to capital allocation decisions, investor confidence, and long-term business value.
The ROCE Formula Explained
The formula itself is refreshingly clean:
ROCE = EBIT ÷ Capital Employed
Where:
Why is EBIT Used?
EBIT is used in its place of net income since the intention of showing the ROCE is to see how well the business is run, rather than how it is funded. Net income combines capital efficiency with debt and tax strategies—things that vary wildly from company to company and are more noise, obscuring the very thing you are trying to measure.
What is Capital Employed?
Capital Employed is the long-term resources the business has deployed to run the business. Current liabilities are excluded as they are short-term and have not been deployed as strategic capital.
Let’s look at an example. Consider a Mid-Market Manufacturing firm with the following reported numbers :
Now let’s say their direct competitor posts an EBIT of $9.2M with an employed capital of $80M. Sounds daunting, right?
Well, not really because their ROCE is only 11.5%. Even though they generate higher earnings in absolute terms, they’re creating less return per dollar of capital invested overall.
Now, here’s the true conversation ROCE enables : not one that net income alone grabs.
ROCE goes beyond just a number on the books and becomes a real strategic tool. Capital is not free.
Every dollar that is used has an opportunity cost: the return that investors expect, the interest that is owed on debt, and the opportunity to do something else that could potentially do better. When ROCE is above that hurdle rate, the company is actually creating value.
When it is not, value is being destroyed quietly, even if the P&L is good and the company is announcing a good quarter.
ROCE is one of the clearest guides for where to invest next. A business unit running 22% ROCE deserves more capital. One sitting at 7% while the cost of capital is 11% is consuming resources without adequate justification—and deserves a harder conversation. Capital allocation strategies anchored to ROCE data produce fundamentally different—and usually far more defensible—investment decisions than those built primarily on gut instinct or revenue growth projections.
Before investing in the buyout or the new region, the savvy financial people think about the impact on consolidated ROCE. Will this really improve the capital efficiency of the company, or will it simply erode it? That is the thing to understand before the term sheet, not after.
The private equity guys and the large lenders care about ROCE because it is one of the key measures of how good the management is. It is a good test to see if the managers know how to handle capital. If the ROCE continues to rise, it is because they are running the place with discipline, in a way that sophisticated people understand and, dare I say it, enjoy hearing about.
Understanding your weighted average cost of capital alongside ROCE helps executives determine whether additional leverage is actually accretive. If borrowed capital funds projects returning 18% while WACC sits at 9%, the math is compelling. If ROCE is marginal and WACC is rising, the same math turns on you quickly and without much warning.
Here's the honest answer: it depends. And anyone who gives you an answer without context is glossing over the part that actually matters.
Capital-intensive industries, like utilities, telcos, and heavy manufacturing, have structurally lower ROCE profiles due to the enormity of their asset bases in relation to their earnings. A 6-8% ROCE in infrastructure is perfectly reasonable. In professional services, it's a cause for concern and deserves an actual conversation about the capital base.
Asset-light industries, like software, consulting, and finance, often have ROCE profiles well in excess of 25-35% due to the high earnings and relatively lower capital base. Comparing these two industries is like comparing a freight hauler to a delivery service in terms of fuel efficiency. Different business models, different expectations.
The one number you should actually care about is your own cost of capital.
The value creation threshold: If ROCE is persistently higher than WACC, value is being created. If it is persistently lower, value is being destroyed – no matter how good the income statement looks, no matter how great the press release reads, no matter how enthusiastic the board deck is. This is how investors and PE sponsors actually think about whether management is building something sustainable or just pedaling furiously on a hamster wheel.
One thing to try to work out: Calculate the ROCE for each significant business unit or product line as a separate entity. The overall number is interesting. The segmented view is usually more interesting – and sometimes less comfortable.
Three related metrics, three different jobs. Here's how they shake out:
ROCE is most useful for evaluating the business holistically, particularly in conversations with lenders and investors who care about the full capital structure picture.
ROA works better for operational comparisons, especially when capital structure differs materially between entities being compared.
ROIC offers sharper precision for investment analysis and peer benchmarking because it removes the distortions created by different tax environments. For a deeper look at financial metrics that matter most depending on business stage, the right metric choice depends heavily on the audience and the decision being supported.
For board-level reporting, ROCE wins on clarity and its direct relationship to financing decisions. For internal capital allocation analysis, ROIC often surfaces cleaner insight. Pick the right tool for the job.
Improving ROCE comes down to two levers: grow EBIT or reduce capital employed. Every strategy is a variation on one of those themes—or ideally, both at once.
Pricing discipline, operational efficiency, and product mix management all flow directly to EBIT without requiring equivalent capital deployment. This is why companies with robust financial planning and analysis functions consistently outperform—they identify margin improvement opportunities that organizations managing by feel consistently overlook until it's inconvenient.
The efficiency of working capital has a direct bearing on the denominator of the ROCE calculation. Tightening receivables, negotiating better terms on payables, or clearing excess inventory all have the effect of reducing capital employed without impacting top-line growth.
So does the sale of under-performing businesses or businesses that are not core to the company, which are consuming capital without delivering adequate return. Sometimes the most impactful capital allocation decision of all is the simplest: returning capital from sources where it was not being earned in the first place.
This is the discipline move that too many organizations delay far too long. Leaving a business with a 5% return on capital employed when the cost of capital is 10% improves the overall return on capital employed—but requires the discipline to walk away from the business, and this is something that makes most management teams feel very uncomfortable doing. It is still the right thing to do when the numbers demand it.
Not all CapEx is created equal. Growth CapEx generating above-hurdle returns should proceed. Maintenance CapEx that preserves existing ROCE is necessary. CapEx that inflates the capital base without commensurate EBIT growth is the one that deserves rigorous challenge before anyone signs the approval form.
A few patterns that distort ROCE and lead to poor decisions downstream—patterns that show up more often than they should:
Net income adds back in interest expense and taxes, both of which reflect decisions around tax optimization rather than true operational performance. ROCE measured against net income conflates capital efficiency with capital structure, producing a number that's harder to compare and easier to accidentally game.
9% ROCE in a regulated utility is nothing to worry about. 9% ROCE in a professional services firm is a cause for concern. Without knowing the capital intensity for that industry in general, ROCE comparison is misleading and causes unnecessary concern or overconfidence.
Of course if a company takes on significant debt of goes through a major acquisition, capital employed is going to turn over on its head. ROCE trends should be read in that context and not treated as a clean abc comparison across periods with huge variations in capital basis.
Early-stage growth businesses investing heavily in platform development will see compressed ROCE during the build phase—by design. Scenario planning that models ROCE through different strategic phases helps executives communicate these trade-offs without the metric being misread as a performance failure in the making.
ROCE isn't a figure you calculate once a year, glance at briefly, and then file away until the auditors start poking around. If you use it properly, it can be one of the most potent tools at your disposal for maintaining capital discipline and presenting a believable performance to the people whose capital you're spending.
The companies that have embedded ROCE thinking into the way they think about projects, businesses, or strategic decisions are making different—and usually better—decisions. They go into meetings with investors with a level of confidence that the companies focused only on revenue models can’t quite match.
What has been consistent across companies at all stages is the recognition of a gap: the financial leaders who understand ROCE in theory have yet to fully embed it in practice.
The capital allocation discussions have been held without ROCE as a reference point.
The acquisition discussions have been held without a clear view of the impact on capital employed. The business units have assets that have yet to generate a return in years, without anyone presenting the analysis in a way that makes the exit feel obvious rather than awkward.
Companies typically disclose their ROCE at a consolidated level. However, they rarely disclose it at a business unit level, a product level, or a geographical level. The top-line figure appears to be healthy, but the stories behind it, where all the action is taking place and where all the decisions are being made, are a far cry.
ROCE is a finance calculation. However, it rarely makes it to the room where capital decisions are being made – hiring, expanding a facility, M&A, technology investments. The calculation and capital decisions are two separate events, and neither is serving the other well.
Management teams typically use industry averages to compare their ROCEs. However, they rarely factor in lifecycle stages, capital structures, and investment windows. This leads to either undue concern or overconfidence – both are unproductive.
If you’re struggling with this, then maybe experienced financial leadership can help change the equation. A few options for professional help can include:
Interim CFO support in a capital-intensive growth phase where ROCE is deliberately kept in check
Fractional CFO partners in providing strategic guidance and aligning capital efficiency metrics to actual investment decisions
Ongoing training and development support for finance teams in terms of performance metrics and capital efficiency
Companies that master capital efficiency thinking attract better capital, negotiate better terms, and walk into board meetings with a cleaner, more credible story.
They make acquisition decisions with sharper discipline. And they exit low-return activities before those activities quietly drain the resources that could be generating far better returns elsewhere.
But here’s the thing: the companies that attract the best capital, get the best deal, and have the best relationships around the boardroom table aren’t always the most profitable – they’re the ones that can prove their capital is working harder than it’s costing them.
That’s the game.
McCracken Alliance is here to help you play that game well – with financial leadership, frameworks, and experience to help you move from calculating ROCE to truly owning your story around capital efficiency.
Get in touch today for a no pressure discussion to discuss building the kind of capital efficiency infrastructure your business deserves.
ROCE measures the efficiency with which the company can convert its broad long-term capital base, including equity and long-term debt, into operating profits. It measures the effectiveness with which the company is creating value, as opposed to simply reporting it in theory.
ROCE uses EBIT and considers all long-term capital employed, whereas ROIC uses after-tax operating profits (NOPAT) and focuses on invested capital. ROIC provides a more precise calculation for comparison between companies when tax rates vary significantly, whereas ROCE is a simpler calculation for use in other situations.
Context is everything. In an asset-light industry, a high ROCE is expected; in a capital-intensive industry, it may suggest that the company is under-invested rather than highly efficient. ROCE must be considered in terms of the company's cost of capital. 18% is high; it's not so impressive if the WACC is 20%.
There are two main levers that drive improvement: lift EBIT without proportionate increases in capital requirements via pricing, margin enhancement, and/or improved operational efficiencies—and reduce the capital employed via working capital improvements, asset disposal, and/or improved CapEx management. Improvement via both levers is often associated with greater improvement, and that is usually where the best opportunities lie.
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