ROCE vs. ROA: What’s the Difference?

The formula to calculate ROCE is as follows:

$begin{aligned} &text{ROCE} = frac{text{EBIT}}{text{Capital Employed}}\ &textbf{where:}\ &text{EBIT} = text{Earnings before interest and tax} end{aligned}$​ROCE=Capital EmployedEBIT​where:​

Capital employed is defined as total assets minus current liabilities or total shareholders’ equity plus debt liabilities. Therefore, it is similar to the return on equity (ROE) ratio, except it also includes debt liabilities.

The higher the ROCE, the more efficiently a company makes use of its available capital to generate profits. The ROCE ratio is especially useful for comparing similar capital-intensive companies. A good ROCE ratio for a company should always be higher than its average financing interest rate.

ROCE is best used when comparing companies in capital-intensive sectors, such as utilities and telecoms, because unlike other fundamentals, ROCE considers debt and other liabilities as well. The ROCE is useful for comparing companies with significant debt.

ROCE may need adjustments, including subtracting cash from capital employed to get a more accurate measure of ROCE. The long-term ROCE is important, where investors favor companies with stable and rising ROCE numbers.

The ROA is similar to the ROCE ratio in that it measures profitability and financial efficiency. The difference is that the ROA ratio focuses specifically on the efficient use of assets.

The ROA ratio divides annual earnings by total assets to indicate how much revenue per dollar is generated in relation to the company’s assets. It is calculated using the following equation:

$text{ROA} = frac{text{Net Income}}{text{Total Assets}}$ROA=Total AssetsNet Income​

A high value of the ROA ratio is a strong indication a company is functioning well, making significant returns from assets. As with other profitability ratios, the ROA is best used to compare similar companies in the same industry.

The differences between the ROCE and ROA ratios are not many, but they are significant. Different profitability ratios exist precisely to enable investors and analysts to evaluate a company’s operational efficiency from various perspectives to obtain a fuller picture of a company’s true value, financial condition, and growth prospects.