Calculating a Company’s ROIC
This calculator can be used to determine a company’s return on invested capital, also referred to as ROIC. The calculator needs a total of eight inputs, including:
- The first two items the calculator requires are found on the income statement, including the company’s EBIT, which are earnings before interest and taxes
- The second income statement item is interest expense
- The first of four balance sheet items is current assets
- A second balance sheet item needed, which also an asset, is cash
- The third balance sheet item is fixed assets
- The last item from the balance sheet that we need is current liabilities
- The current income tax rate is also required to perform this calculation
- Finally, while not a critical component and if available, the calculator needs the company’s after-tax cost of capital
The calculator then provides the user with six outputs:
- The company’s net income, which is found by subtracting interest expense from EBIT and then adjusting for income taxes
- The company’s operating profit after taxes, which is found by adjusting net income for income taxes associated with interest expense
- The company’s non-cash working capital, which is found by subtracting cash and current liabilities from current assets
- The company’s invested capital, which is found by adding non-cash working capital to fixed assets
- Finally, we can calculate ROIC by dividing operating profit after taxes by invested capital
- If you supply the company’s after-tax cost of capital, we can also subtract that value from ROIC to find the company’s excess returns
Why Do Companies Track Return on Invested Capital?
There is certainly no shortage of financial measures companies can use to understand their performance. For example, there are profit margins that measure how efficiently a company controls cost when making a product or providing a service. One of the metrics used to measure how well a company uses assets to generate profits is return on assets, or ROA. This metric is found by dividing net income by the total assets of the company. The flaw with ROA is found in its simplicity. Namely, it includes all assets in the denominator. That’s why some companies measure return on invested capital, or ROIC too.
By design, ROIC measures invested capital. Instead of using all assets like ROA, ROIC adds non-cash working capital to fixed assets. Property, plant, and equipment are the three categories of fixed assets. This means fixed assets includes items like company vehicles, land, buildings, computers and other office equipment, as well as machinery. Non-cash working capital starts with current assets and then subtracts out both cash as well as current liabilities. These adjustments allow for a clearer picture of the company’s return on assets it has “put to work” in some manner. Since all the information required to calculate ROIC is readily available for publicly traded companies, it can also be used to benchmark performance against a set of peers.
Calculating Excess Returns
We’ve already launched a weighted average cost of capital calculator, which provides insights into the cost associated with raising funds. If that value is known, it can be entered into the after-tax cost of capital field used by the calculator. By comparing the cost of capital to the return on invested capital we can determine the “excess returns” the company earns on those investments. For example, if the company’s cost of capital is 10% and their return on invested capital is 15%, their excess returns would be equal to 5%. All three of these values (weighted average cost of capital, return on invested capital, and excess returns) provide valuable insights into the ability of a company’s leadership to make prudent investment decisions.