# Understanding Return on Average Capital Employed (ROACE): Definition and Formula

![Return on Average Capital Employed](https://www.investopedia.com/thmb/-mpr98BBD5Tfnc5nBkqa6MlqbgI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/return-on-average-capital-employed-roace-final-88868957658840d48f5282029ff8a8f6.png)

*— Investopedia / Zoe Hansen*

## What Is Return on Average Capital Employed – ROACE?

Return on average capital employed (ROACE) shows how well a company uses its money to make profits. Unlike [ROCE](https://www.investopedia.com/terms/r/roce.asp), which looks at capital at one moment, ROACE uses the average over time, giving a clearer picture. It’s especially useful in industries like oil and gas that need big investments. You can calculate ROACE by dividing earnings before interest and taxes (EBIT) by a company's average capital. Investors and analysts like ROACE because it tells them how efficiently a company turns investments into profits.

*   ROACE measures profitability against a company's self-investments, using average assets and liabilities.  
    
*   It is particularly useful for analyzing capital-intensive industries like oil.  
    
*   ROACE compares a company's profitability with its total investments, appealing to fundamental analysts and investors.  
    
*   ROACE smooths figures over time, accounting for seasonal business fluctuations.  
    
*   Depreciating assets can artificially inflate ROACE, masking a lack of new investments.

## How to Calculate ROACE

﻿ $\begin{aligned} &\text{ROACE} = \frac{ \text{EBIT} }{ \text{Average Total Assets} - \text{L} } \\ &\textbf{where:} \\ &\text{EBIT} = \text{Earnings before interest and taxes} \\ &\text{L} = \text{Average current liabilities} \\ \end{aligned}$﻿

## Insights Gained from ROACE

Return on average capital employed (ROACE) is a useful ratio [when analyzing businesses](https://www.investopedia.com/ask/answers/011315/how-useful-roce-indicator-companys-performance.asp) in capital-intensive industries, such as oil. Companies that earn more profit with less capital have a higher ROACE than less efficient ones. The formula for the ratio uses EBIT in the numerator and divides that by average total assets less average [current liabilities](https://www.investopedia.com/terms/c/currentliabilities.asp).

Analysts and investors use ROACE to compare a company's profitability to its total new capital investments.

## Practical Example of ROACE Application

As a hypothetical example of how to calculate ROACE, assume that a company begins the year with $500,000 is assets and $200,000 in [liabilities](https://www.investopedia.com/terms/l/liability.asp). It ends the year with $550,000 in assets and the same $200,000 in liabilities. During the course of the year, the company earned $150,000 of revenue and had $90,000 of total operating expenses. Step one is to calculate the EBIT:

﻿ $\begin{aligned} &\text{EBIT} = \text{R} - \text{O} = \$150,000 - \$90,000 = \$60,000 \\ &\textbf{where:} \\ &\text{R} = \text{Revenue} \\ &\text{O} = \text{Operating expenses} \\ \end{aligned}$﻿

The second step is to calculate the average capital employed. This is equal to the average of the total assets minus the liabilities at the beginning of the year and the end of the year:

﻿ $\begin{aligned} &\text{CB} = \$500,000 - \$200,000 = \$300,000 \\ &\textbf{where:} \\ &\text{CB} = \text{Capital employed beginning of year} \\ \end{aligned}$﻿

﻿ $\begin{aligned} &\text{CE} = \$550,000 - \$200,000 = \$350,000 \\ &\textbf{where:} \\ &\text{CE} = \text{Capital employed end of year} \\ \end{aligned}$﻿

﻿ $\begin{aligned} &\text{AC} = \frac{ \$300,000 + \$350,000 }{ 2 } = \$325,000 \\ &\textbf{where:} \\ &\text{AC} = \text{Average capital employed} \\ \end{aligned}$﻿

Lastly, by dividing the EBIT by the average capital employed, the ROACE is determined:

﻿ $\begin{aligned} &\text{ROACE} = \frac{ \$60,000 }{ \$325,000 } = 18.46\% \\ \end{aligned}$﻿

## Comparing ROACE and ROCE

Return on capital employed (ROCE) is a closely-related financial ratio that also measures a company's profitability and the efficiency with which its capital is employed. ROCE is calculated as follows:

$\begin{aligned} &\text{ROCE} = \frac{ \text{EBIT} }{ \text{Capital Employed} } \\ \end{aligned}$

[Capital employed](https://www.investopedia.com/terms/c/capitalemployed.asp), also known as funds employed, is the total amount of capital used for the acquisition of profits by a firm or project. It is the value of all the assets employed in a business or business unit and can be calculated by subtracting current liabilities from total assets. ROACE, on the other hand, uses _average_ assets and liabilities. Averaging over time helps remove the impact of outliers, like seasonal business spikes or declines.

## Understanding ROACE Limitations

Investors should use caution with this ratio as assets like refineries depreciate over time. If the same amount of profit is made from an asset each period, the asset [depreciating](https://www.investopedia.com/terms/d/depreciation.asp) will make ROACE increase because it is less valuable. This makes it look as if the company is making good use of capital, though, in reality, it is not making any additional investments.

## The Bottom Line

ROACE is a financial measure that compares a company's profitability to the average capital it invests. Unlike ROCE, which looks at capital at one point in time, ROACE takes the average of opening and closing capital, giving a better view of financial health. It is calculated by dividing EBIT by average total assets minus average current liabilities. Investors use ROACE to see how efficiently a company uses its capital and to compare profitability across companies. There are limitations, since asset depreciation can make results look better. Analysts and investors can use it to judge a company’s performance and make better financial decisions.