ROCE (Return on Capital Employed) - Explained in Hindi | #30 Master Investor - YouTube

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Namaskar, my name is Mukul & you are welcome to Asset Yogi

Where we unlock the knowledge of finance rather than locking it

This video is a part of a series in which we are discussing Financial Ratios

In this video, I will talk about Return on Capital Employed

In our previous video, we talked about Return on equity

In which we have seen that How much return investors get on their capital, this is called Return on equity

Return on capital employed, your total capital in any business, equity capital (investors/owners) along with loans & liabilities

That is also added because you are using capital in that business

We will see, how much returns we will get on our total capital

This is known as Return on capital employed (ROCE)

We will see this in detail, watch the video till the last, let's move to the blackboard

We are discussing Profitability Ratio

Profitability Ratio is of two types - Return on Sales, which means how much returns we get on company's sales

The second is, Return on Investment, which means returns we get on investing money in a company

I have already made a video on Return on Sales, in which we have discussed Gross margin, operating margin, net margin

I have also made a basic video on Return on Investment

We have already discussed, Return on Equity, which is how much return owners & investors get on their invested money

In this video, we will see Returns on Capital Employed

That is, how total returns are calculated on total capital whether the money is of owners/investors or loan of any bank

Then in the 3rd video, we will see Return on Assets, which is How to calculate returns on total assets of a company

Now, we will talk about Return on Capital Employed

We have seen Eqn., Assets = Equity + liability

These are all the portions of equity

So, Assets = Equity + liabilities

I have done further bifurcation, Equity = equity share capital, that is initial capital when a business is started

Then, Reserves surplus, which is as the business grows it produces cash or reserves

Then, Preferred equity, when you take money from friends/family

And you say to give them returns before any other equity shareholders

Equity share capital + reserve surplus = common equity

And other is Preferred equity, all this together are Equity

Now, liabilities are of 2 types

One is Current liabilities, other is Non-current liabilities

Current liabilities are short term, whose payments are to be done in <1year

Non-current liabilities are long term, whose payments can be done in >1year

We will see the further division of Current liabilities & Non-Current liabilities

Current liabilities include, Short term Debt, then Trade payable

Like creditors from which you have taken goods on loan but money is to be returned

Then Advances & Overdues, you have taken advance from any customer or payments are overdue

Then there can be more short term liabilities whose payments are to be done in <1year

Non-current liabilities include Long term debt, which is a loan taken for more than 1 year

Then Deferred Tax liability, if your business is such that you have differed tax liabilities & remaining are other long term liabilities

Now we will talk about the return on capital employed

Let's say, we want to calculate the return on capital employed of a company from this income statement

So, what will be the ROCE

ROCE = profit/capital employed

As we have seen in the video of return on equity

Return on equity = profit after tax/total equity

This is the total equity which we divided by profit after tax

When we calculate the ROCE, what profit we will take?

Do we take profit after tax?

No, you don't have to take profit after tax

I have already mentioned why we have taken profit after tax

We have to see priorities that how money is going

Long term debt payment has to do first

So, short term & long term debt payments are to be done first

So see, the payment of interest is done firstly, this is your operating profit

EBIT (Profit before interest & taxes/Earnings before interest & taxes)

In that, the first payment is done of interest

Then comes Profit before taxes, then your Tax payment is done

So, firstly you have to do the payment of Debt from your operating profit, which is the loan given by the bank

Then the government will take Tax

And after that, you will get Profit after Tax

On third no., you give returns to Preferred Equity

If you have promised any dividends to preferred equity shareholders then you give returns to them

And on fourth no.

Are, Common equity shareholders

When we talked about ROE, we talked about the overall total equity

We said that profit after tax was taken because firstly we will do the payment of interest & tax & then shareholder will get money

In ROCE, we are taking the overall total capital

The overall total capital is been taken

So basically, we don't have to pay interest & tax, we have to take profit even before that

We have to take EBIT (Earnings Before Interest & Taxes)

So, this profit will be PBIT (Profit Before Interest & Taxes)

I have explained this topic so that you don't make any mistake

So basically you will understand the logic

What will we take capital employed here?

There are so many questions on capital employed,

We can calculate 6 different types of ROCE

I will show an example in which on 3 different websites, 3 different ROCE are calculated for the same company

Our main purpose is to be consistent & stick to the formula we are already using

You will find somewhere that, capital employed

Many companies & analysts consider, equity + non-current liabilities

So, equity is fixed & we have to take it anyway

But in current & non-current liabilities, which one's are to be taken?

Many people take equity & Non-current liabilities, they say that

We are not taking Current liabilities because the short term effect is not that much

So we want to take long term liabilities

Then sometimes people say that, divide PBIT with equity + long term debt

They only consider long term debt, they want that

We want to calculate only that much money which is employed or taken or capitals on which we are getting returns

And long term debt is the main debt as there is no effect of short term debt

The third formula is, PBIT/equity + long term debt + short term debt

You have to add both short & long term debt

If you asked to me

According to me, this one is the ideal definition

If I have to calculate, I will divide PBIT by all three, Equity, L.T debt, S.T debt

In practice, many times you may have not the information of short term debt, but you have information on long term debts

A long term debt last long generally

Practically you can use this also

Taking all the non-current liability is not right according to me

Because in that deferred liability & other long term liability also comes, which may not be your capital employed

It is not given by the bank so it is not appropriate to include it

Because you want to find out the returns on the total capital which you employed

According to me, If you want to calculate ideally, then it is the best method to calculate ROCE

Different analysts use the different definitions

Let's do one calculation of this

In the capital- the whole equity

This is your equity portion

Second, Is your short-term & long-term debt

Let's say your equity capital share in this company is 1Cr

Reserved & surplus 50L, Preferred equity is 50L

Let's say they had taken a short-term debt of 50L & Long-term debt of 1.5Cr

If we calculate ROCE

Here for now I'll take both short term & long term Debt

What will do here

We have to took EBIT on the upside

80L on the upside, in a numerator

In denominator- whole equity, which is 200L and

Add Long-term debt of 150L & short-term debt of 50L

On addition, it comes 400L

If you divide it, your ROCE of 20% come

The second formula which is more practical, in this you can take equity + L.T debt

Let's calculate by that too, PBIT is 80L/(200L of equity & 150L L.T debt)

If we calculate this is 80L/350L it is come out 22.86%

The question is not which formula gave the best value

We have to focus on the practical definition of this

We have to view how it is compared to the other companies

Whatever formula you use, you have to stick to that on comparing the companies

Do not use a different formula to calculate other company value

That is more important

I think, here the concept for the calculation of ROCE is clear to you

Let us look at some other important points of ROCE

Why do we need ROCE?

Here we will try to know the difference between ROE & ROCE

In the last video, we have seen in an ROE

It is not able to give us an overall picture of the returns on total capital

And Return on Equity can be manipulated

As we have seen in the last video,

If you, ROE means

You represent to the investors that you gave maximum returns to him

So, you will increase your debt portion

Which can be dangerous, many times

Especially when economic condition is not okay

So, I suggest you, watch my video of ROE

You will exactly understand

How do some companies do the fianacial engineering

And hows the loss can he occurred

ROCE is mainly required to know the overall returns

On the capital employed in the company

Second, by ROCE you can compare the returns of your different investments

So you can decide, you should invest or not

You can compare to other investments such as

FD's, mutual funds, bonds or any other business & company you invested

You should invest where ROCE is greater than a Cost of capital

What is the cost of capital, let's say the interest rate of your loan is 12%,

Then your ROCE should be more than the 12%

If it is not, then what is the benefit of that business, because 12% will be taken by the bank

Your returns will be 0

That's why it is so important that your ROCE should be greater than the cost of capital

Means should be more than interest

If you invest all from a loan, here we discuss a totally hypothetical situation

Otherwise, you should take the weighted average cost of capital

I will make a separate video on the "weighted average cost of capital"

If I talk ideally, your ROCE should be greater than the weighted average cost of capital

In weighted average cost of capital

There is some portion of equity, then you have to give some dividend to a shareholders

So that's why we find the overall cost of capital and

Compare to that, your ROCE should be more than that, then only you have a profit as a businessman in it

Let us try to find out the ROCE of Reliance Industries

Here I have opened three websites, to look at the value of ROCE

Money Control, India Info Line, equity Master

We will see the value of ROCE in all three

Here we come in the ratios, basically, we have to see the consolidated one

According to money control, they calculate the return on capital employed for March 2018 is 7.7%

This is according to the money control, ROCE on the consolidated balance sheet for the reliance industries

Now we look in the IIFL, I opened the consolidated balance sheet for the reliance industries

Here also we go in ratios and see what ROCE they calculated for March 2018 is 10.60%

As you see, the two websites calculate the ROCE in different

Now we see in the equity master, what ROCE they calculate for reliance industries

So this the data of balance sheet of it, ROCE is given here in last, it is for March 2018 is 13.1%

So the ROCE on the three different websites is totally different

The main reason behind this a, which I told you earlier

They are using a different formula to calculate ROCE, 6 different analysts can give you 6 different ROCE

What the main thing is you should consistent to one formula that you using

That is if you compare the ROCE of RIL, Indian Oil, BPCL or HPCL

You should compare it on the same site

They have taken PBIT/equity+L.T debt

I calculate it quickly to show you

What we need first is PBIT, so we go to the income data

Here profit before tax is given, PBIT directly not given to you

Therefore you have to add the interest portion to it

Our PBT is 49367Cr

All the value is given here in millions

We take 49367Cr

And your interest is 8025Cr, you have to add it, then you get your PBIT

We scroll down to see the long term debt & net worth(equity)

Your equity come to 293506Cr

And long term debt of 144175Cr

Here I'll quickly calculate to show you

We have seen a PBT of 49367

We have to add interest to it, the interest of 8025Cr

If we add this we will get the PBIT

The total PBIT come 54419Cr

Net worth this, and long-term debt is this

Basically, we calculate the capital employed here is

Equity(293506) + long-term debt(144175)

Our capital employed come out to be 43681Cr

For the Return on capital employed, you divide PBIT(57419) by the capital employed(43681)

If you calculate then it comes to 13.1%

As we see earlier see here ROCE is13.1%

Here I understood the formula they used

But I cannot understand what formula IIFL & money control used to calculate ROCE

As a said it is not important, you should use only one website whenever you compare the ROCE of two companies

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