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ROE vs ROCE#

How ROE and ROCE are different?#

ROE (Return on Equity) vs. ROCE (Return on Capital Employed)#

Both ROE and ROCE are profitability ratios, but they measure returns on different parts of a company’s capital and cater to distinct perspectives:

1. ROE (Return on Equity)#

Definition:#

ROE measures how effectively a company generates profits using the shareholders’ equity. It shows the return earned on the money invested by shareholders.

Formula:#

\[\text{ROE} = \frac{\text{Net Profit (PAT)}}{\text{Shareholders' Equity}} \times 100\]

Key Focus:#

  • Focuses only on equity shareholders’ returns.

  • Ignores debt or borrowed funds.

2. ROCE (Return on Capital Employed)#

Definition:#

ROCE measures the overall profitability and efficiency of a company in generating returns using total capital employed, which includes both equity and debt.

Formula:#


\[\text{ROCE} = \frac{\text{Operating Profit (EBIT)}}{\text{Capital Employed}} \times 100\]

Where:


\[\text{Capital Employed} = \text{Total Assets} - \text{Current Liabilities}\]

Or:


\[\text{Capital Employed} = \text{Shareholders' Equity} + \text{Long-term Debt}\]

Key Focus:#

  • Considers returns on both equity and debt capital.

  • Reflects the company’s efficiency in using all available capital.

Key Differences#

Metric

ROE (Return on Equity)

ROCE (Return on Capital Employed)

Focus

Measures returns on shareholders’ equity.

Measures returns on both debt and equity capital.

Formula Base

Uses Net Profit (PAT).

Uses Operating Profit (EBIT).

Capital Base

Considers only Shareholders’ Equity.

Considers Equity + Long-term Debt (Capital Employed).

Perspective

Reflects profitability from shareholders’ viewpoint.

Reflects overall operational efficiency.

Leverage Impact

Leverage (debt) can boost ROE artificially.

ROCE accounts for the cost of debt, offering a balanced view.

When to Use ROE vs. ROCE#

  1. ROE: Focus on shareholder returns. Useful when analyzing companies with low or no debt.

  2. ROCE: Evaluate the efficiency of total capital utilization, especially important for companies with significant debt.

Example:#

Given:#

  • Net Profit (PAT): $50 million

  • Operating Profit (EBIT): $70 million

  • Shareholders’ Equity: $200 million

  • Total Assets: $500 million

  • Current Liabilities: $100 million

  1. ROE:

    \[\text{ROE} = \frac{50,000,000}{200,000,000} \times 100 = 25\%\]
  2. ROCE:

    \[\text{Capital Employed} = 500,000,000 - 100,000,000 = 400,000,000\]
    \[\text{ROCE} = \frac{70,000,000}{400,000,000} \times 100 = 17.5\%\]

Conclusion:#

  • ROE is higher (25%) as it focuses on equity returns.

  • ROCE is slightly lower (17.5%) as it considers the cost of capital employed (debt + equity).

Both metrics offer valuable insights, but ROCE provides a more holistic view of operational efficiency.

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