Page 289 - Cambridge IGCSE Business Studies

23: Analysis of accounts

Return on capital employed
KEY TERM
Th e return on capital employed (ROCE) ratio shows profit before tax as a

Return on capital employed percentage of capital employed. It tells us how much profit is earned for every $1

(ROCE): ratio between profit invested in the business. This ratio is the most used measure of effi ciency and is

before tax and capital employed.

often considered to be the most important way of analysing a business’s profi tability.
Capital employed is the amount invested in the business by the owners, for
example sole trader, partners or shareholders. Any long-term borrowing, such as
debentures, should also be included as capital employed. The money is usually

borrowed to purchase profit earning assets such as buildings and machinery.

Return on capital employed = profit ×100
capital employed

EXAMPLE

Using the data from Table 23.2, the 2012 return on capital employed for TT is:

63
Return on capital employed (2012) = × 100
120
= 52.5%
This measure tells us that every $1 of capital invested in TT earned a return to the shareholders of $0.525.

ACTIVITY 23.4 287

Copy out the table below.

Performance ratio 2012 2013
Gross profit margin 45%

Profit margin 15%
Capital employed 52.5%

1 Use the data in Table 23.2 to calculate the performance ratios for 2013.
2 Using your results, comment on the financial performance of TT in 2013 compared to 2012.
3 Explain how the following stakeholders of TT might view these results.
a Shareholders
b Employees
c Suppliers
d Government
4 Based on the information, do you think a bank would lend money to TT to finance expansion plans? Justify
your answer.

As with the other ratios you have studied so far, the return on capital employed
ratio is of little use unless it is compared with the business’s ROCE results from
previous years, or with the ROCE results of similar businesses in the industry.
As a general rule, if the ROCE increases from one year to the next, or the business

has a higher ROCE than competitors, the business’s profitability has improved or is

better than similar firms in the industry.