What it means
Most return measures start from net profit, which is shaped by accounting rules such as depreciation (spreading the cost of an asset over its life) and the timing of revenue recognition. CROCI starts from cash flow instead, so it shows what a business actually produces in spendable cash.
For analysts who distrust reported earnings, that is a big attraction. The denominator, invested capital, is the total money tied up in the business, such as equity, debt and the cost of the assets in use.
Some versions of the measure adjust the figures for inflation, or for items such as leases and pensions, so that companies with older assets can be compared fairly with those with newer ones. Definitions differ between analysts, so it is wise to check which version is being quoted.
A high CROCI suggests a business earns generous cash from the capital it employs, which often points to a strong competitive position. A low figure suggests capital is being tied up with little cash to show for it.
Comparing CROCI with the company's cost of capital (the return investors and lenders require) shows whether the business is creating value. The measure is especially useful in capital-heavy industries such as utilities, energy and manufacturing, where depreciation can distort profit.
It also works well for comparing companies within the same sector, where capital intensity is similar. Like any ratio, CROCI is a snapshot and can be volatile if cash flow swings from year to year.
Analysts usually look at an average over several years, and they check whether a high figure comes from sustainable operations or from a one-off cash inflow.
In practice
Real-world examples.
Example
An equity analyst compares two water utilities. One reports higher profit, but the other has a better CROCI because it generates more cash relative to the pipes and plants it owns, which leads the analyst to prefer the second. Her report explains that cash returns are a better guide to long-term dividend safety than reported earnings.
Example
A private equity investor screens manufacturing businesses for a purchase. She uses CROCI to avoid companies whose profit looks healthy only because of favourable accounting estimates, and focuses on those with strong cash returns. The extra screening step saves her team from spending weeks on due diligence for a business whose cash flow does not support its valuation.
Example
The chief financial officer of a retail chain tracks CROCI by region. She finds that new stores in one area produce much lower cash returns than the capital invested in them and slows the roll-out until the problem is understood. Her board now receives the regional figures every quarter alongside the usual profit reports.
Formula
Calculation
CROCI = Cash flow from operations / Invested capital x 100
Worked example: a manufacturer generates cash flow of $18,000,000 in the year. Its invested capital is $120,000,000.
CROCI = $18,000,000 / $120,000,000 x 100 = 15%.
If the company's cost of capital is 9%, the CROCI of 15% is six percentage points higher, suggesting the business is creating value above what investors require.
A rival with the same cash flow but invested capital of $180,000,000 would have a CROCI of $18,000,000 / $180,000,000 x 100 = 10%, so the first company uses its capital more efficiently.Case study
Seen in the real world.
Bluewater Logistics is a fictional freight company, and this case is purely illustrative. Its reported profit had risen for three years, and the board assumed the business was performing well.
An outside analyst calculated CROCI and found it had fallen from 14% to 8%, because the company had added expensive warehouses faster than cash flow had grown. Profit looked fine because depreciation was low on the new buildings, but cash returns were slipping. The finance director later admitted that the board had been looking at the wrong scoreboard, and that the cash view should have been part of its reporting from the start.
The board paused new warehouse spending, sold two underused sites and focused on filling the space it already owned. Over the next two years CROCI recovered to 12%, and the board began to review capital projects against a minimum cash return.
Watch out
Common mistakes.
- Assuming every analyst defines CROCI the same way, when cash flow and invested capital can be adjusted in several different ways.
- Using a single year of data, which can be distorted by a one-off cash inflow or a heavy investment year. Smoothing the figure over three to five years gives a far more reliable picture of the underlying business.
- Comparing companies in very different industries, where normal capital intensity and cash returns vary widely. A software company and a shipping company will have very different capital needs, so compare like with like.
Questions
People also ask.
How is CROCI different from return on capital employed?
Return on capital employed uses accounting profit, while CROCI uses cash flow, which makes it less sensitive to depreciation and accounting policy. Profit-based ratios are still useful, but CROCI adds a check that profit is turning into actual cash.
What counts as a good CROCI?
It depends on the industry, but a figure comfortably above the company's cost of capital is generally a positive sign. Some analysts also compare CROCI against the average for the sector to judge whether a company stands out.
Why do investors like cash-based measures?
Cash cannot be easily altered by accounting estimates, so cash-based ratios give a clearer view of real performance.
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