How Useful is the Return on Capital Employed (Roce) as a Performance Indicator?

Abstract

The use of the Return On Capital Employed (ROCE) as a performance indicator is questioned in this paper. The paper is using the premise that performance indication can only be meaningful to the user if it bears a true reflection of the relationship that it intends to measure. An empirical evaluation of financial statements of 16 firms listed on the Nigerian Stock Exchange reveal that ROCE as currently defined presents distorted and misleading financial ratio which bears no relationship with the actual capital usage of a firm. It also revealed that a true measure of efficiency in the use of capital resources cannot be done using capital employed as defined in a company's balance sheet. This is because the balance sheet capital is a static measure of capital employed at a date and not for the entire period. Hence, the result to be obtained from such measurement would invariably be influenced by the static nature of the value of capital employed as at that date. A more refined approach considered the firm's actual capital turnover (usage) ratio and presents an Enhanced Return On Capital Employed (EROCE) ratio measurement that correlates better with a firm's capital employed using the Spearman's correlation coefficient formula. The study recommends the replacement of the ROCE with EROCE for maximum effectiveness.

Keywords: Return On Capital Employed, Enhanced Return On Capital Employed, ROCE, EROCE, Market Value Analysis, MVA, Capital Turnover Ratio, CTR, Accounting Ratios, Capital Employed, Net Profit, Capital Turnover Rate

JEL Classification: M41, D42, E22, G14, G32