Published: 05th Nov 2024
By: Value Research
Return on capital employed (ROCE) is a widely used metric that measures a company’s ability to generate profits from its capital (shareholder equity plus debt). It indicates the efficiency with which a company uses its capital to earn returns.
It looks at all capital—old and new. This can obscure how effectively a company is using fresh investments. Enter Incremental ROCE that focuses on recently invested capital. It tells us if new investments are really paying off, beyond the existing capital base.
Here's an example. In FY23, a company had Rs 1,000 crore capital & made Rs 100 crore in profit, a ROCE of 10%. By FY20, its capital was Rs 2,000 crore with Rs 250 crore profit…
Divide the change in operating profit (Rs 250 crore-Rs 100 crore) by the change in capital employed (Rs 2,000 crore-Rs 1,000 crore). And you will get an incremental ROCE of 15%. This shows a 15% return on the new capital, better than the initial 10%!
It tells us how effectively a company is using new funds. High Incremental ROCE means a company is increasing its ability to turn new capital into profit, which is crucial for long-term growth.
These two situations can result in a negative incremental ROCE, but these are false alarms. Buybacks and dividends may lower available capital, but this is not a bad sign. To understand how, check the details in our story from the link below.
Other Webstories
To find more such stories & Web-stories, visit our website