Return on invested capital (ROIC)

This is a ratio that can be used to assess how effectively a company squeezes profits from the assets it controls and owns. The basic formula for the number takes trading profits and deducts tax before dividing by the total capital to give a percentage.

So if a firm’s trading profits is £70m, taxes are £20m and total capital employed is £500m, then ROIC is (70-20)/500, or 0.1, which as a percentage is 10%. The higher this is the better, and it could be compared to, say, the return you can get from other less risky investments such as a bank account.

To see whether 10% is a good result you also need to compare ROIC to the cost of capital for the firm. If it costs a firm 15% in annual borrowing costs to generate 10% ROIC, then the firm isn’t creating value for shareholders. Ideally, you want a decent positive gap between ROIC and a firm’s cost of capital.

Merryn

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