MSG Team's other articles

11874 Intrinsic Value and Mispricing

The whole objective of equity valuation is to find mispriced securities. Investors can make abnormal profits when they find securities which are lower than their intrinsic worth trading in the market. However, the concept of mispricing and intrinsic value is misunderstood to say the least. What the average person considers as mispricing is at best […]

12784 Commercial Banks and Branch Banking

The business model behind commercial banking practice has completely changed over the years. Earlier, commercial banks were heavily dependent upon branch banking. Branches that served corporate customers were thought of as being an asset. As a result, it was common for corporate banks to advertise these branches to prospective clients. However, over the years, the […]

9665 How Risk-Based Supervision System Works?

In the previous article, we have already studied what risk-based supervision is. We now know why regulatory bodies all across the world are adopting the risk-based supervision system and what its benefits are. However, it is also important to understand the manner in which a risk-based supervision system can be implemented. The details of the […]

11000 Revenue From Releasing Players for International Tournaments

Professional sports athletes play for certain sports franchises throughout the year. However, these same players also represent their nation when it comes to international events. One good example would be the FIFA World Cup. It needs to be understood that all good players such as Lionel Messi and Cristiano Ronaldo play for their respective countries. […]

11049 Risks Involved in Derivative Contracts

Derivatives are considered to be extremely risky. The market is divided in two fronts when it comes to the opinion about risks involved in a derivative contract. Some people are of the opinion that since derivatives are not new securities by themselves, how can they introduce new risk in the market? The opposing camp agrees […]

Search with tags

  • No tags available.

Return on Invested Capital (ROIC) is another popular metric that is used widely in financial analysis. The reason for its popularity is that like ROA, ROIC can be used by both equity and debt holders. Also, like ROA, it provides data about return to the company as a whole and is not affected by leverage. Here is more about Return on Invested Capital;

Formula

The formula for calculating ROIC is as follows:

Return on Invested Capital = EBIT / Invested Capital

  • Deriving Invested Capital: Note that Invested Capital is not the same as Capital listed on the balance sheet. Neither is it the balance sheet total. Invested Capital is a term analysts have coined in the recent past to denote capital that has been listed for the long term in the company’s operations.

    Invested capital is derived by starting from the Balance Sheet Liabilities total and then subtracting the current liabilities from it. This is because current liabilities are not sustainable sources of long term financing and therefore cannot qualify as capital.

Meaning

The Return on Invested Capital (ROIC) metric measures the company’s efficiency at allocating its resources to generate the maximum return. Thus ROIC shows the relationship between invested capital and return. It must be thought about as having Rs X in earnings for every rupee in invested capital.

Assumptions

  • Tax Planning not Considered: The Return on Invested Capital (ROIC) used EBIT which is a pre-tax figure. This ratio does not consider that companies can make significant differences to their profitability with the help of tax planning strategies. Some analysts use both pre-tax and post-tax ROIC numbers to get a better picture of the company’s operations.

  • Accurate Book Values: The Return on Invested Capital (ROIC) assumes that the book values stated are accurate. In many cases, the book values and the market values of assets are very different. One such example is land. Thus, ROIC becomes a misleading figure. This is because many times analysts consider the opportunity cost based on market value and the ROIC drops drastically.

Interpretation

    No Break-Up Provided: ROIC does not provide break up about whether income has been earned from regular operations or from one time activities.

    Used to Evaluate Acquisitions: Return on Invested Capital (ROIC) is useful in case of companies that have done many acquisitions. Since it is difficult to segregate the cash flows of the two merged companies, ROIC with and without the acquisition serves as a measure of gauging success.

Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

What are Common Size Statements ?

MSG Team

Cash Ratio – Meaning, Formula and Assumptions

MSG Team