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Concept
Return on capital
Summary
Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital invested by shareholders and other debtholders. It indicates how effective a company is at turning capital into profits.
The ratio is calculated by dividing the after tax operating income (NOPAT) by the average book-value of the invested capital (IC).
ROIC = NOPAT/Average Invested Capital
There are three main components of this measurement that are worth noting:
While ratios such as return on equity and return on assets use net income as the numerator, ROIC uses net operating income after tax (NOPAT), which means that after-tax expenses (income) from financing activities are added back to (deducted from) net income.
While many financial computations use market value instead of book value (for instance, calculating debt-to-equity ratios or calculating the weights for the weighted average cost of capital (WACC)), ROIC uses book values of the invested capital as the denominator. This procedure is done because, unlike market values which reflect future expectations in efficient markets, book values more closely reflect the amount of initial capital invested to generate a return.
The denominator represents the average value of the invested capital rather than the value of the end of the year. This is because the NOPAT represents a sum of money flows, while the value of the invested capital changes every day (e.g., the invested capital on December 31 could be 30% lower than the invested capital on December 30). Because the exact average is difficult to calculate, it is often estimated by taking the average between the IC at the beginning of the year and the IC at the end of the year.
Some practitioners make an additional adjustment to the formula to add depreciation, amortization, and depletion charges back to the numerator. These charges are considered by some to be "non-cash expenses" which are often included as part of operating expenses.
Official source
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