ROE Vs ROCE

Return on equity and return on capital employed are both profitability ratio that use by management, investors and shareholders to assess how entity use equity and capital. The high of these ratios, the more efficiency of equity and capital are used. Return on equity using the relationship between net income for the period with averages of equity or equity at the end of the period. Return on capital employed on the other hand use profit before interest and tax for the period, and capital employed. Although these two ratios use to assess profitability of entity, they both are different on certain things.

The following are the major different between return on equity and return on capital employed.

Objective: Equity Vs Capital Employed

The objective of assessing return on equity and return on capital employed is quite different. ROE intend to assess how the efficiently the equities are used and manage. Equity can be calculated by taking liabilities from assets. That mean all kind of liabilities are eliminated. However, ROCE is intended to assess how capital employed are manage and use in the entity. Normally, capital employed are bigger than equity if we use the same financial information. The main reason is capital employed include the long term liabilities. This is probably the big part that make this ratio different.

But, what are the reason behind this?

Well, basically the equity is the net worth of the entity but capital employed is the combination of net worth of entity plus long term liabilities. That mean ROE want to assess only the return to net worth, but ROCE want to know the return to net worth plus long term liabilities. These are the main reason why these two ratios use different profits figure.

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Using of profits figure:

Another areas that make ROE different from ROCE is using of profit figure to calculate the ratio. ROE uses net profit for its calculation and ROCE uses profit before interest and tax for its calculation. As you could see, these both ratios use different types of profit for calculation.

But what are the reasons that these two ratio use different profits figure?

Well, let go back to the objective above. ROCE use profit before interest and tax because it want to assess the return on capital employed while this capital employed include long term liabilities.

Let see this formula,

Capital employed – long term liabilities = total equity

And,

Profit before interest and tax – interest and tax = net profit.

So the major different here interest and tax in the profit figure and long term liabilities in capital employed.

Now we can use this,

(Interest and tax) / Long term liabilities

Therefore, these two ratios using different figure are because of the different of capital employed and equity.