Return on Invested Capital
(ROIC)

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What is Return on Invested Capital?

ROIC is an instrument that can be used for measuring the historical performance of a business unit or of an entire company.

Discounted Cash Flow ultimately drives the (future) value of any company (leading indicator). However, short-term cash flow results are not useful for performance measuring, because cash-flows are easy to manipulate. For example by delaying capital spending, by postponing advertising campaigns or by decreasing R&D levels. ROIC is a lagging indicator; it provides information on how a company has performed in the past.

Usage of Return on Invested Capital. Benefits

The ROIC model is often used to assess the value creation capabilities of a firm or firms in an intuitive way. High (relative) ROIC levels are seen as proof of a strong company and/or solid company management. However great care should be taken. A high ROIC may just as well be an indicator of poor management, caused by harvest behavior, by ignoring growth possibilities, and by long-term value destruction.

Limitations of Return on Invested Capital. Disadvantages

Since Return on Invested Capital is an accounting-based measure, it suffers the following potential concerns:

• Can be manipulated by management,
• Is influenced by accounting conventions and by changes in accounting conventions, and
• Is affected by inflation and currency exchange movements.

What can be said is that companies earning less than their Cost of Capital usually can not create value by growing alone, unless their Return on Invested Capital moves up above the Cost of Capital (WACC).

Calculation of ROIC. Formula

ROIC = Net Income After Tax / Invested Capital

ROIC = After Tax Operating Earnings / (Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities)

More accurately, ROIC = Net Operating Earnings before Interest and Amortization Charges, but after Cash Taxes / (Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities)

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide

Book: Ciaran Walsh - Key Management Ratios

Forum Forum discussions about Return on Invested Capital. 🔥 Valuation of a Business Based on its Assets (Invested Capital) When selling or buying a company or part of it, is it possible to determine the value of the entity based on the capital it invested in its assets? Yes, but beware of following valuation pitfall: Peo... 11   1 comments What is Return On Invested Capital (ROIC)? In my understanding, ROIC = [Net Operating Profit - Adjusted Tax] / [Invested Capital]. ROIC is used to measure how well companis generate earnings from invested capital in their business. If ROIC is... 6   Start a new topic about Return on Invested Capital Sign up for free

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Compare with:  EBIT  |  EBITDA  |  Economic Value Added  |  Cash Ratio  |  Current Ratio  |  Earnings Per Share  |  Return on Equity  |  Return on Investment  |  Return on Capital Employed

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