Return on Average Capital Employed (ROACE) Formula | Calculation with Example - YouTube

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by clicking the friends today we;re going to learn a concept that is return on average

capital employed formula one of the really significant ratio see we can see over hear the formula

return average capital so we're finding what return on the capital employed so over here

it's going to earning before interest Income Tax so EBIT which is known as your operating

profit divide by your capital employed but you are capital employed is what average this

is very important let's understand the return are that is ROACE formula ROACE that is

return on capital employed now why they invest in a company why do they invented the

company because the want to grow with the company return average capital employed basically

help them to find out whether they should invest in the company or not know this is

important is a significant part so ROACE formula is this is not similar as return

on capital employed it is not similar to ROACE here we're calculating the return on the average

capital that we need to consider both the beginning capital and the ending capital employed

the ROACE formula is basically your profitability ratio and it has invested to find out how

much return how much return the money get from the investment they would make in a company

let's understand the formula ROACE is equal to your EBIT earning before interesting

tax divide by your average capital employed this is your formula now let's understand

this with a simple example so that we get some idea ka simple example to illustrate

ROACE formula this company called benefit Inc it is a some following information something

like this it has your EBIT which is your $30,000 then it has beginning capital that

is big cap the letters $54,000 and the ending capital let se $4,50,000 so what we need

to find we need to find ROACE formula so first we need to find out the average capital

employed over here so average capital employed is going to be your beginning capital write +

your ending capital so this is the summation this is a summation you need to divide this

by due to get average write the beginning capital and the ending capital I am sorry

this should be 540000 right so we get 425000 average capital employed by using this return

on average capital formula we get ROACE formula that is ROACE formula is basically

your EBIT divide by average capital employed so let's divide this the average capital employed

this is 495000 sorry we need to divide 30,000 average capital employed we get a answer as

please convert this into percentage we get 6% 6.06 closed after that for 6% is

the the return on average capital employed so this was basically hypothetical example

but now let's understand this with the help of a real life example and will take company

cal Nestle Nestle return on average capital employed this is a screenshot of the consolidated

income statement as on 31st December 2014 and 2015 for Nestle and you can see the operating

profit that is been highlighted over which is 12408 for 2015 and 10905 for 2014 right

we need another thing that is the capital employed so we need to go down and check out

the total current liability wages 33321 and 32895 if we go down little bit we get total

liabilities and equity as 123992 and 133450 figures that I important and all of them are

highlighted right in front of us the current liability total liability and equity and the operating profit

right and 2014 in 2015 both and then the total Assets and the total current liability

for 2014 and 2015 so let's consider the operating profit for 2015 write the operating profit is 12408

so let's jot down some numbers over here the operating profit lets pick up the numbers

from your 12408 and 10905 ,12408 and 10905 this is for 2015 and this is for 2014 I have

the capital employed right we have 123992 ok and we need to deduct of the total current liabilities

from that so will take the figures over here 123992 -33 33321 so that is 90671 that share

capital employed for 2015 and for 2014 is 133450 and 32895 so let's deduct that 133450

less 32895 that will give us just to particular so this is your capital employed capital and

this was of basically operating profit so base on this so we can calculate the average capital

right should be quite easy the opening capital + closing capital this whole thing divide

by 2 I am not protein in bracket 95613 is average capital and our formula future

supply return on average capital employed ROACE is going to be your operating profit

12408 average capital and convert this in percentage we get answer as 12.98% per that

is 13% on the next note if we see we need to understand the explanation part of the

return on the average capital employed formula see in this above ratio we have to pass the

first part the first and foremost what is our EBIT the early before interest and tax

see EBIT is actually your operating income now if we look if you look at the income statement

PN&L as we call of the company would see that after deducting the operating expenses

from the gross profit we get the operating income or which is known as your EBIT and

taking EBIT into consideration instead of net income there should be this question is because in only

operating income directly reflects the income generated the income generated from the business

moreover operating income does not include income from the other sources so make sure that this

second important criteria in our formula the part is the average capital employed this

is the II part C the first approach is that you know if he if you can simplify add your

equity and your long term debts if any but there is a second approach which is better

than the first approach in the second approach with deduct what do we detect the current

liabilities the CL from the total assets or we can add the equity and non-current liability

II approach is better because it directly shows that what has been directly invested

in the business meaning this approach also includes any other sort of non current liabilities

other than other than that this is your calculator for your formula if u put EBIT is over here let;s say

500000 and your average capital employed as let's 1 million so your average capital

employed is going to be 50% not keeping this average capital employed as same if we reduce

this as $4,50,000 your ratio is going to go down and if we increase

this the ratio is going to go up so you can make and conclusion put your numbers and get

some amazing result of this so that's it for this particular topic if you have learnt enjoyed

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