Return on Capital Employedby Udit Jain on June 13, 2007
Return on Capital Employed (ROCE)
is defined as:
Pre-tax Profit x 100 = ROCE
Retailers make widely varying returns but as a sweeping generalization, a business should be making at least 16% to be considered a successful business. A good analogy is to consider that you could invest $100 in a retail business or you could put it in a savings
institution. In a savings institution you might currently earn 3% to 8% depending on investment, country and the prevailing level of inflation. To invest that money in
a retail business carries a higher level of risk and should therefore, earn a higher level of reward. The capital is invested in fixed assets and working capital. Fixed assets include buildings, fixtures and fittings, trucks, refrigeration units, etc. In retail, the biggest part of working capital is usually inventory. Accounts payable is another component, as is accounts receivable, which for most retailers is the balances outstanding on credit and debit cards that haven’t been settled yet.
A variant on this measure is Return on Net Assets. This measures the pre-tax profit divided by the net asset value expressed as a percentage. For the purposes of this paper, they lead you to the same conclusions. To improve the performance of your business, you can improve pre-tax profit, or reduce the capital employed to achieve the same profit, or do a mixture of the two.
Improving pre-tax profit requires some mix of:
• Growing sales.
• Increasing gross margin percent.
• Reducing expenses as a percent to sales.
Reducing the level of capital employed to make a given profit involves:
• Squeezing more productivity out of fixed assets such as selling space and fixtures.
• Reducing the inventory investment necessary.
• Collecting settlement faster from the credit card companies and banks.