ROCE (Return on Capital Employed) - Explained in Hindi | #30 Master Investor

Return on Capital Employed

Return on Capital Employed (ROCE) is a financial ratio that measures how efficiently a company is using its capital to generate profits.
ROCE takes into account both the equity capital (invested by owners) and borrowed capital (loans and liabilities) of a business.
It indicates the return an investor can expect on the total capital employed in a business.

"ROCE is a financial ratio that measures how efficiently a company is using its capital to generate profits."

Calculation of ROCE

ROCE is calculated by dividing the profit generated by the company by the total capital employed.
The profit considered for ROCE calculation is the operating profit before interest and taxes (EBIT).
The total capital employed includes equity capital, reserve surplus, preferred equity, long-term debt, and short-term debt.

"ROCE = profit/capital employed"

Different Definitions and Formulas for ROCE Calculation

There are different definitions and formulas used by analysts for ROCE calculation.
Some analysts consider equity plus non-current liabilities as the capital employed.
Others choose to include equity plus long-term debt or equity plus long-term debt and short-term debt.
The choice of formula depends on the analyst's preference and the purpose of the analysis.

"Different analysts use different definitions and formulas for ROCE calculation."

Importance of Consistency in ROCE Calculation

It is important to maintain consistency while calculating ROCE.
Comparisons between companies should be based on the same formula.
Using different formulas for different companies can lead to inaccurate comparisons.

"We have to focus on the practical definition of ROCE and stick to that when comparing companies."

Practical Example of ROCE Calculation

Let's take an example of a company with equity capital of 1Cr, reserve surplus of 50L, preferred equity of 50L, short-term debt of 50L, and long-term debt of 1.5Cr.
The EBIT for the company is 80L.
Calculating ROCE using the formula EBIT / (equity + long-term debt + short-term debt) gives a result of 20%.

"If we calculate ROCE for this example, it comes out to be 20%."

Considering Different Formulas for ROCE Calculation

Different formulas can be used to calculate ROCE, such as equity plus non-current liabilities or equity plus long-term debt.
The choice of formula should depend on the practical definition of capital employed and comparability with other companies.

"We have to view how ROCE is compared to other companies, regardless of the formula used."

ROCE (Return on Capital Employed) - Explained in Hindi | #30 Master Investor" by "Asset Yogi" provides an in-depth explanation of Return on Capital Employed (ROCE). The video discusses the calculation of ROCE, the importance of consistency in ROCE calculation, and offers practical examples. It also explores different definitions and formulas used by analysts for calculating ROCE. The video provides valuable insights into understanding and analyzing the financial performance of a company.

Why do we need ROCE?

ROE (Return on Equity) is not able to give us an overall picture of the returns on total capital. It can be manipulated.
ROCE is required to know the overall returns on the capital employed in the company.
By using ROCE, you can compare the returns of your different investments and decide where to invest.
It helps you compare the returns of different investments such as FDs, mutual funds, bonds, or other businesses and companies.

"ROCE is mainly required to know the overall returns on the capital employed in the company."

Importance of ROCE being greater than the cost of capital

The cost of capital refers to the interest rate of your loan. If your ROCE is not greater than the cost of capital, there will be no profit as the interest will be taken by the bank.
To have a profit as a businessman, your ROCE should be greater than the cost of capital.

"That's why it is so important that your ROCE should be greater than the cost of capital, means should be more than interest."

Different calculations of ROCE by analysts

Different analysts can use different formulas to calculate ROCE, which can result in different values.
It is important to be consistent with one formula when comparing the ROCE of different companies.

"Different analysts can give you different ROCE. The main thing is you should be consistent with one formula that you are using."

Example calculation of ROCE for Reliance Industries

PBIT (Profit Before Interest and Tax) needs to be calculated to find ROCE.
The formula used by the speaker: PBIT / (Equity + Long-term Debt)
PBIT is calculated as Profit Before Tax + Interest
The capital employed is calculated as Equity + Long-term Debt
The ROCE is obtained by dividing PBIT by the capital employed.

"For the Return on capital employed, you divide PBIT(57419) by the capital employed(43681). If you calculate then it comes to 13.1%."