What is Return on Employed Capital and Why Should You Care?
Return on Employed Capital (ROEC) tells you how well your company is using its capital to generate earnings. It's like knowing if your financial workout routine is giving you gains or just wearing you out.
Why Should You Care?
ROEC is quite the superstar in the world of finance because it tells us how effectively a company is using its capital to make money. A high ROEC can signal to investors that a company is doing a great job at turning its investments into profits. Conversely, a low ROEC can be a red flag, indicating that a company might need to tighten its belt and find ways to be more efficient.
How to Calculate ROEC
You just need two pieces of information: Earnings Before Interest and Tax (EBIT) and Fixed Capital (FC). The formula is:
[\text{ROEC} = \frac{\text{Earnings Before Interest and Tax (EBIT)}}{\text{Fixed Capital (FC)}} \times 100]
Where:
- Earnings Before Interest and Tax (EBIT) is the profit a company makes before deducting interest and taxes
- Fixed Capital (FC) is the amount of money invested in long-term assets, like buildings or machinery
You can also use EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) in place of EBIT for more accurate results in some cases.
Calculation Example
Imagine the following scenario:
- Your company's EBIT is $500,000
- The fixed capital invested is $2,000,000
Plugging these values into the formula:
[\text{ROEC} = \frac{500000}{2000000} \times 100]
This simplifies to:
[\text{ROEC} = 25%]
Your company's ROEC is 25%. This means that for every dollar of fixed capital invested, your company is generating 25 cents in earnings before interest and tax.
Tips for Using the ROEC Calculator
- Double-check your inputs: Make sure you have accurate figures for EBIT and Fixed Capital; otherwise, your ROEC will be off
- Compare over time: Use ROEC to compare your company's performance over different periods to spot trends
- Benchmark against peers: Check out what ROECs look like for companies in the same industry to see how you stack up