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Return on Capital Employed ROCE

SandyHoodSandyHood Font Of All KnowledgeRegistered, Moderator Posts: 2,034
The ROCE ratio is a central measure of how well the management of a business is using the resources it has to produce profits.

In a typical PEV question you would be looking at the operating profit generated using the total investment in the business.

Finding the figure for operating profit is usually reasonably easy.
Sometimes finding a value for the total investment can be more difficult.
Because a balance sheet (by definition) balances there is more than one way to find the value of the investment.

Typically text books will suggest finding the shareholders' funds (share capital plus reserves) and adding on long-term loans.
If this information isn't available you would get the same figure by adding
fixed assets and net current assets together (in balance sheets drawn up using UK reporting standards this is often labelled as total assets less current liabilities)

So having found a value for capital employed, you can divide the operating profit by this amount to get a % return. (ROCE)

In some recent examiner model answers the Return on Net Assets (RONA) has been used for questions asking for ROCE. This makes no difference unless the business has some of the finance from long-term loans.
The net assets total is a smaller value as it does not include the long-term loans. It is equal to the shareholders' funds (or equity).
So if you divide your operating profit by the net assets the answer will be a higher %.

If you use RONA to answer ROCE questions, the model answers indicate that you will be given full credit.
But the most important thing is consistency, if in a question you have worked out the ROCE and then you have updated a profit and loss account and net assets value to produce a revised ROCE you should use the same formula. That way you can compare the ratios on a common basis, and make your observations.

I hope that is some help on a topic that can sometimes cause problems.

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Sandy
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www.sandyhood.com
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