Return on Capital

Return on Capital - Investment valuation KPI

Return on capital is a financial and accounting KPI which is commonly used by senior operations mangers to gauge the rate of return a business is generating on the book value of the capital the company’s owners or shareholders currently have invested in the business. The Return on Capital measure is also used by businesses as a threshold to select and execute capital expenditure projects that may present themselves from time to time, specially when adding new production capacity.

Formula for Return on Capital

ROC = Net operating profit after tax / (BvEq+BvDebt – Cash)

Legend:

BvEq: Book value of equity
BvDebt: Book value of Debt
Cash: Cash and cash equivalents

Significance of Return on Capital

Return on Capital is such an important measure for business and operations managers as it gives them a measure to compare what kind of return the business’ capital is generating carrying on the business to other rates of return such as investing capital in other investments, businesses, or comparing it to the cost of capital for the business. Usually each company will have its own minimum rate of return on capital objective, which is usually above its own weighted cost of capital plus a few percentage points. This is one of the hurdles that must be satisfied when evaluating internal projects before capital expenditure approval.