Return on capital employed

Return on capital employed measures how much operating profit a company generates relative to the total capital it has tied up in the business, both debt and equity combined. It answers a fundamental question for any capital-intensive business, how efficiently is management turning the capital invested in the company into profit.

The formula is:

Capital employed represents the long-term funding base a company uses to run its operations, its total assets minus its short-term liabilities that don't carry a financing cost, like accounts payable. Because the ratio uses operating income and total capital employed rather than net income and equity, it captures returns to both debt and equity holders together, which makes it useful for comparing companies with different capital structures, unlike return on equity, which only reflects the return to shareholders and can be inflated by leverage alone.

A high and rising return on capital employed suggests a company is generating strong profit from the capital it has invested and often points to a durable competitive advantage, since sustaining high returns typically requires some form of pricing power or cost advantage that keeps competitors from bidding those returns away. A return on capital employed that's below the company's cost of capital is a warning sign, it means the business is generating less profit than what that capital could have earned elsewhere, effectively destroying value even if the company is nominally profitable. It's especially useful for comparing capital-intensive businesses like industrials, utilities, and telecoms, where large amounts of capital are tied up in physical assets.