Return On Average Capital Employed (ROACE)
Return On Average Capital Employed (ROACE) is a ratio that reveals the profitability against the investments made in the company. The ROACE is different from Return On Capital Employed for it counts the average of the opening and closing capital for the specific period contrasting to only the capital figure at the end of a period.
Calculation of Return On Average Capital Employed
ROACE = EBIT / (Average Total Assets - Average Current Liabilities)
where EBIT is Earnings Before Interest and Taxes.
Interpretation of ROACE
The Return On Average Capital Employed is best employed in the analysis of businesses in capital-intensive industries, oil for example. The businesses capable of squeezing higher profits from a smaller amount of capital assets will feature a higher ROACE as compared to those which are not efficient in transforming capital into profits.
Investors should be cautious while using Return On Average Capital Employed in analyzing a business as the capital assets, like refinery, can be depreciated over passing time. When an asset generates the same amount of profit over every period, the depreciation of the assets will lead to a higher ROACE. This indicates that the company is making good use of capital, but the company is actually not making any additional investments.