Return on capital employed is the total profit received from the business against the total capital invested in the business. If your business earned Rs. 50 Lakhs and the total amount invested in the business is Rs. 100 Lakhs, then you can say that the return on capital employed is 50%.
In the above example, ROCE = Rs. 50 Lakhs divided by Rs. 100 Lakhs = 50%
Now let’s see the ROCE of some of the listed companies in India
- Nestle India – 146%
- Hind. Unilever – 117%
- Colgate-Palmoliv – 67%
- Hawkins Cookers – 62%
- P & G Hygiene – 58%
- Marico – 43%
- Page Industries – 53%
- Century Textiles – 10%
From the above examples, you can see that ROCE can be above 100%. It can be a single-digit number and it can be even a negative number.
Even though, earlier I told you that the ROCE is calculated by dividing profit with capital employed. But in the real world of calculation, there is a slight change in the method of calculation. Instead of taking the final profit, we should take PBIT that is Profit Before Interest and tax, and should divide it with capital employed.
If you don’t want to do the calculation on your own, then the best site from where you will get the data as a final figure is https://www.screener.in/,
If you want to calculate the data by yourself, then you need to go to the company website and download the annual report from the website. In the case of Nestle India, you can download the latest annual report from here https://www.nestle.in/investors/stockandfinancials/annualreports.
Below I will be explaining the ROCE of Nestle India as per the 2020 annual report.
In this example, the profit before tax (also known as profit before tax or PBT) is 28,127.9 and Finance Cost is Rs. 1641.8 million
Here, when you add interest expenses with “Profit Before Tax”, you will get PBIT. As simple as that. That means the PBIT is this example is Rs. 28,127.9 + Rs.1,641.8 Million = Rs. 29,769,7 Million. So now we know how to calculate the PBIT which is the numerator in ROCE calculating formulae.
The next step is to calculate “Capital Employed”
Capital employed simply means the total amount you have invested in the business to date. Now basically you have 3 components that are counted under capital employed. They are equity, reserves & surplus, and debt. Equity is the amount raised from promoters and other shareholders directly or through IPO.
Just for example, when you are the only investor in the business, you have 100% shareholding. When you have invested Rs. 1 Crore in a business and your partner also invested the same amount in the same business then you have 50% shares of the business and your partner also will get 50% shares of the business. Just like that, based on the number of investors and based on the amount they have invested, they will get proportionate shareholding. Once the company turns from a private company to a public company, many investors will invest in the same business through IPO and based on the number of shares public buy through IPO they also will become the shareholders. The point I am trying to convey is, through all these methods, companies raise money and against which they issue shares to the investor and the money raised this way is called equity.
The second source of capital employed is debt. Debt simply means the amount company raised from banks or through the public through a corporate debt fund. In this case, the company is obliged to give back the principle amount at a later stage with the interest amount. The amount company raised through dividends is invested in the business.
The third part of the capital employed is reserves and surplus. This is the remaining part of the profit company has achieved after issuing a dividend to the shareholders. The amount from profit after the dividend is reinvested in the company that is added along with the amount raised through equity and debt and will become a part of the total capital employed.
All these 3 things, equity, debt and reserves & surplus will together form the capital employed. Now let’s see from where you will find the Capital Employed in the annual report. All items under the capital employed can be located under the balance sheet. The equity part, you can find from the Equity and liabilities section. In this case, the total equity is Rs. 20,193 Million. Under equity, you can see equity share capital and other equity. Equity share capital is the amount company raised through IPO. Other equities include reserves and surplus. To find the details of equity share capital and other equity section, you can go to the “notes” numbers 18 and 19 after the financial statement. So now you know from where you will get the equity and reserves & surplus part.
Next comes the borrowing part. The company will have 2 types of borrowings. One is long-term borrowing which is also called non-current borrowings and the other one is short-term borrowings which is also called current borrowings. As given in the below image, you will get the long-term borrowings from the non-current liabilities under the liabilities section and you will get the short-term borrowing under the current liabilities under the liabilities section itself. In this case, the long-term borrowing is Rs. 317 million and short-term borrowing is Rs. 31 million.
So to get the total capital employed, you need to add total equities (which is the sum of capital raised through IPO and also reserves and surplus), long-term borrowing and short-term borrowing. In this example, the values will be Rs. 20,193 million + Rs. 317 million + Rs. 31 million which will be Rs. 20,514 million. So the final capital employed is Rs. 20,154 million
So, to calculate the final ROCE you should divide PBIT with capital employed which is Rs. 20,154 million divided by Rs. 29,769,7 Million = 145%, which means if you have run a business like this, when you invest Rs. 1 Crore, by the end of the year you will get a profit of Rs. 1.45 Crores. Nice, is it?
Also read: Largest library on economic moats
Also read: Fundamental analysis of Tesla, Inc
Also read: What is cryptocurrency?
Also read: What is financial literacy?
Also read: What is return on capital employed or ROCE?
Also read: You “need” a car but you “want” a BMW
Also read: Being rich and wealthy are not the same