When it comes to financial metrics there is important to know each metrics' merits and demerits. There are two such popular financial metrics ROE and ROCE. From the perspective of equity stockholders, ROE is useful. ROCE is meaningful from the capital allocation of the company's point of view. Which is a better metric for analyzing a company when it comes to the return on capital versus the return on capital employed? Is it better to have a higher ROE or a higher ROCE? Let us debate the ROE Vs ROCE and understand more about it.
ROE stands for Return on Equity. It is a metric used to assess the profitability of a business in relation to equity. It is the amount of net income of a company expressed as a percentage of its shareholder's equity. ROE measures how much profit a company generates as compared to its shareholder's equity. Thus, the higher the ROE means the company is generating more profit for its shareholders.
ROE = Net income / Equity of shareholder
ROCE stands for Return on Capital Employed. It is a financial metric used to measure the profitability of a company in terms of all of its capital. ROCE measures how well a company is generating profit from its capital. Thus, the higher the ROCE, the better the chances of profits. Investors look for higher ROCE as compared to competitors before arriving at an investment decision.
ROCE = EBIT / Capital Employed
EBIT = Earning before interest and tax
Capital Employed = Total assets - Current liability
ROE Vs ROCE | Difference between ROE and ROCE:
- The purpose of ROE is to determine how effectively a company's equity is used and managed. And the purpose of ROCE is to evaluate how well the firm uses and manages its utilized capital.
- ROE gauges the profitability for equity shareholders. Whereas ROCE gauges the profitability for all the stakeholders including equity and debt.
- For calculating ROE net profit means profit after tax uses. ROCE uses operating profits or EBIT for calculating ROCE.
- ROE is a significant ratio from an investor's point of view whereas ROCE is a significant ratio from a company's perspective.
- When ROCE is higher than ROE, loan holders have rewarded more than equity shareholders.
- According to Warren Buffet, both should be above 20%. The closed they are to one another, the better and any significant differences between them should be avoided.