Return on Invested Capital (ROIC)

Return on Invested Capital (ROIC)

Return on invested capital (ROIC) is a profitability ratio that measures a company's ability to generate profits from its invested capital. ROIC is calculated by dividing a company's net income by its invested capital. Invested capital is equal to a company's total assets minus its current liabilities.

ROIC is a valuable metric for investors because it provides a measure of a company's efficiency in using its capital. A high ROIC indicates that a company is generating a lot of profit from its investments, while a low ROIC indicates that a company is not using its capital effectively.

ROIC can be used to compare companies within the same industry to see which companies are more profitable. It can also be used to track a company's profitability over time to see if it is improving or declining.

There are a few things to keep in mind when using ROIC. First, ROIC is a relative measure, so it is important to compare companies within the same industry. Second, ROIC can be affected by a company's capital structure. Companies with a lot of debt will have a lower ROIC than companies with a lot of equity. Third, ROIC can be affected by a company's accounting policies. Companies that use aggressive accounting policies may report a higher ROIC than companies that use conservative accounting policies.

Despite these limitations, ROIC is a valuable metric for investors and analysts. It provides a measure of a company's profitability and efficiency, and it can be used to compare companies within the same industry and track a company's profitability over time.

How to Calculate ROIC

ROIC is calculated by dividing a company's net income by its invested capital. Invested capital is equal to a company's total assets minus its current liabilities.

The formula for ROIC is:

ROIC = Net Income / Invested Capital

Net Income

Net income is a company's profit after taxes. It is calculated by subtracting a company's expenses from its revenue.

Invested Capital

Invested capital is equal to a company's total assets minus its current liabilities. Total assets are a company's assets, such as cash, accounts receivable, inventory, and property, plant, and equipment. Current liabilities are a company's liabilities that are due within one year, such as accounts payable and accrued expenses.

Example

Let's say a company has $100 million in total assets and $50 million in current liabilities. Its invested capital would be $100 million - $50 million = $50 million. If the company has $10 million in net income, its ROIC would be $10 million / $50 million = 20%.

Interpreting ROIC

A high ROIC indicates that a company is generating a lot of profit from its investments. A low ROIC indicates that a company is not using its capital effectively.

Conclusion

ROIC is a valuable metric for investors and analysts. It provides a measure of a company's profitability and efficiency, and it can be used to compare companies within the same industry and track a company's profitability over time.