Unlocking Financial Success- Mastering the Calculation of Return on Invested Capital (ROIC)

How to Calculate Return on Invested Capital

Calculating the return on invested capital (ROIC) is a crucial metric for evaluating a company’s financial performance. It measures the efficiency of a company in generating profits from the capital invested in its operations. In this article, we will discuss the importance of ROIC and provide a step-by-step guide on how to calculate it.

Understanding Return on Invested Capital

Return on invested capital is a financial ratio that indicates how much profit a company generates for each dollar of capital invested in its operations. This ratio is essential for investors and analysts as it helps them assess a company’s profitability and efficiency in using its capital. A higher ROIC indicates that a company is generating more profits from its capital, making it a more attractive investment.

Components of Return on Invested Capital

To calculate ROIC, you need to gather information on three key components:

1. Net Operating Profit After Tax (NOPAT): This is the company’s operating profit after accounting for taxes. It can be found on the income statement or calculated by subtracting taxes from earnings before interest and taxes (EBIT).

2. Total Invested Capital: This is the total amount of capital invested in the company’s operations. It includes both debt and equity. You can find this information on the balance sheet.

3. Average Total Invested Capital: Since ROIC is an annual measure, you need to calculate the average total invested capital over the period you are analyzing. This can be done by adding the total invested capital at the beginning and end of the period and dividing by two.

Calculating Return on Invested Capital

Now that we have a clear understanding of the components, let’s move on to the calculation process:

1. Calculate NOPAT: Subtract the company’s taxes from its EBIT to get NOPAT.

2. Determine Total Invested Capital: Find the total invested capital on the balance sheet.

3. Calculate Average Total Invested Capital: Add the total invested capital at the beginning and end of the period and divide by two.

4. Divide NOPAT by Average Total Invested Capital: Divide the NOPAT by the average total invested capital to get the ROIC.

Example

Let’s say a company has an EBIT of $10 million, a tax rate of 30%, and a total invested capital of $50 million at the beginning and end of the year. Here’s how to calculate the ROIC:

1. NOPAT: $10 million – ($10 million 30%) = $7 million
2. Average Total Invested Capital: ($50 million + $50 million) / 2 = $50 million
3. ROIC: $7 million / $50 million = 0.14 or 14%

In this example, the company has a ROIC of 14%, which means it generates $0.14 in profit for every dollar of capital invested.

Conclusion

Calculating the return on invested capital is a vital step in assessing a company’s financial performance. By understanding the components and following the steps outlined in this article, you can determine how efficiently a company is using its capital to generate profits. A higher ROIC can be a strong indicator of a company’s potential for future growth and profitability.