What it means
Return on average capital employed, or ROACE, compares operating earnings with the average capital used by a business over a period, and one common version divides earnings before interest and tax (EBIT) by the average of opening and closing capital employed. It is a performance ratio, not a cash return paid to investors.
Investopedia describes the calculation, while Saudi Aramco's published non-IFRS definitions illustrate that companies may report capital-return metrics using company-specific adjustments, so an investor metric is not a mandatory accounting standard. Capital employed can be defined as total assets less current liabilities, or as equity plus interest-bearing debt adjusted for certain balances, and the two approaches can give different numbers if applied inconsistently.
Choose a definition suited to the analysis, use it across periods, and explain how leases, cash and discontinued operations are treated. Because definitions vary, report the exact numerator and denominator and read a company's reconciliation before comparing its published percentage with another firm's.
The average denominator matters when a company invests during the year, because a large asset bought near year end contributes little profit yet all of its closing capital appears in a simple closing-balance calculation. In a simple example, EBIT of $3 million, opening capital employed of $20 million and closing capital employed of $30 million give average capital of $25 million and ROACE of 12%.
If the $10 million increase occurred only in December, that two-point average may overstate the capital actually in use for most of the year, so monthly weighted averages can be more informative and the averaging method should be stated with the result. EBIT is an accounting profit measure that can include estimates, depreciation and one-off items, so a company with high ROACE may still face cash shortages or large future replacement costs.
Compare operating cash flow and capital expenditure alongside the ratio, and do not interpret it as a bank-balance yield. A rising ROACE may reflect better pricing, higher asset utilisation or improved cost control, but it may also rise because capital employed fell after asset sales or write-downs, which is not automatically a healthier business.
A falling ROACE may reflect a new project that has not yet reached full output, or it can signal poor demand, cost overruns or assets that are no longer productive, so a single year's decline is a prompt for analysis rather than a verdict. The ratio is particularly relevant to capital-intensive businesses, but a port, software firm and retailer use different mixes of physical assets, working capital and intangible spending, and accounting policy and lease treatment can differ even within one industry.
Compare like with like, break down both numerator and denominator so management knows why the ratio moved, and supplement the ratio with project and cash measures. Cost of capital provides a useful benchmark, with caution.
Earning more on capital than its financing cost can suggest value creation, but ROACE based on EBIT is a pre-tax accounting measure and a weighted-average cost of capital is often stated after tax, so treating any ROACE above the cost of capital as automatically good is too simple. ROACE is strongest when definitions are consistent, capital timing is understood and accounting profit is considered alongside cash and risk.
In practice
Real-world examples.
Example
An energy company reports ROACE of 12% after dividing EBIT of $3 million by average capital of $25 million. Its annual report explains how it defines capital employed and treats leases. Analysts can therefore compare the figure with earlier years on the same basis.
Example
A manufacturer makes a large investment mid-year, so a simple closing-balance return looks unusually low. Averaging opening and closing capital gives a fairer picture than a closing-only ratio, although a monthly weighted average would be fairer still. The finance team states which method it used.
Example
Managers set a target of ROACE above the cost of capital. They remember that EBIT is pre-tax and cost of capital is often after tax, so they align the two measures before judging performance.
Formula
Calculation
ROACE = EBIT / ((Opening capital employed + Closing capital employed) / 2) x 100
Worked example. EBIT is $3,000,000, opening capital employed is $20,000,000 and closing capital employed is $30,000,000.
- Average capital employed = ($20,000,000 + $30,000,000) / 2 = $25,000,000.
- ROACE = $3,000,000 / $25,000,000 x 100 = 12%.
- For comparison, using only closing capital would give $3,000,000 / $30,000,000 x 100 = 10%, and using only opening capital would give 15%.
The averaging method should always be stated with the result.Case study
Seen in the real world.
This illustrative and entirely fictional case follows Gulf Terminals, an invented port operator that adds a berth partway through the year. Management reports EBIT and both opening and closing capital, then tests a monthly weighted average because the investment timing matters. The board gains context, but a higher or fairer return is not assumed. Suppose EBIT is $6 million, opening capital is $40 million and closing capital is $60 million, with the $20 million berth entering use in October.
The simple average is $50 million, giving ROACE of 12%. A monthly weighted average assumes $40 million for nine months and $60 million for three, which is ($40 million x 9 + $60 million x 3) / 12 = $45 million, giving ROACE of about 13.3%. The board notes that the berth only just started earning, so the higher figure still says little about its long-term return. It asks for the next two years of results before drawing a conclusion.
Watch out
Common mistakes.
- Using only closing capital after a large investment without explaining timing.
- Comparing companies with different EBIT or capital-employed definitions.
- Calling a high accounting ratio proof of strong cash flow or value creation.
Questions
People also ask.
What is ROACE?
An operating-earnings return on average capital used in the period.
Why use an average?
It can reduce distortion from changes in capital, although a two-point average has limits.
What is a good ROACE?
Judge it against comparable periods, risk and an aligned cost-of-capital measure, not a universal threshold.
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