How do you calculate the return on invested capital (ROIC) from financial statements?
Get insights into calculating the return on invested capital (ROIC) from financial statements to assess a company's capital efficiency.
Return on Invested Capital (ROIC) is a financial metric used to evaluate a company's efficiency in generating returns for its investors or shareholders from the capital invested in the business. To calculate ROIC from financial statements, you'll need the following information:
Net Operating Profit After Tax (NOPAT): NOPAT is the company's operating profit (EBIT - Earnings Before Interest and Taxes) adjusted for taxes. You can usually find this figure on the income statement.
Total Invested Capital: Invested capital represents the total amount of capital invested in the business, including both equity and debt. It is calculated as follows:
Total Invested Capital = Total Equity + Total Interest-Bearing Debt
- Total Equity can be found on the balance sheet.
- Total Interest-Bearing Debt includes both long-term and short-term debt and can also be found on the balance sheet.
Once you have these two figures, you can calculate ROIC using the following formula:
ROIC = NOPAT / Total Invested Capital
Here's a step-by-step guide on how to calculate ROIC from financial statements:
Obtain the company's income statement and balance sheet for the period you want to analyze (usually annual or quarterly).
Calculate NOPAT:
NOPAT = Operating Profit (EBIT) * (1 - Tax Rate)
The tax rate is the company's effective tax rate, which can also be found on the income statement or in the footnotes to the financial statements.
Calculate Total Invested Capital:
- Total Equity: This can be found on the balance sheet as "Total Shareholder's Equity."
- Total Interest-Bearing Debt: This includes both long-term and short-term debt, which can also be found on the balance sheet as "Total Liabilities" or "Total Debt."
Total Invested Capital = Total Equity + Total Interest-Bearing Debt
Finally, plug the values into the ROIC formula:
ROIC = NOPAT / Total Invested Capital
The resulting ROIC percentage represents the return on capital that the company generates for its investors after accounting for taxes and the capital invested in the business. A higher ROIC indicates better capital efficiency and is generally a positive sign for investors and analysts.
Calculating Return on Invested Capital (ROIC) Using Financial Statements.
To calculate ROIC using financial statements, you will need the following information:
- Net operating profit after taxes (NOPAT)
- Invested capital
NOPAT is a measure of a company's operating profitability, calculated by taking earnings before interest and taxes (EBIT) and subtracting taxes.
Invested capital is the total amount of capital that a company has used to fund its operations. It is calculated by adding the company's debt and equity.
Once you have this information, you can use the following formula to calculate ROIC:
ROIC = NOPAT / Invested capital
Example
Let's say that a company has the following financial information:
- NOPAT = $100 million
- Invested capital = $500 million
Plugging these numbers into the ROIC formula, we get the following:
ROIC = $100 million / $500 million = 20%
This means that the company is generating a 20% return on its invested capital.
Interpreting ROIC
A higher ROIC is generally considered to be better, as it means that the company is more efficient at using its capital to generate profits. However, it is important to compare a company's ROIC to its weighted average cost of capital (WACC). The WACC is the average cost of the company's capital, including its debt and equity. If a company's ROIC is higher than its WACC, then it is creating value for its shareholders.
Limitations of ROIC
ROIC is a useful metric, but it is important to note that it has some limitations. For example, ROIC can be affected by a company's accounting policies and its industry. Additionally, ROIC does not take into account all of the factors that can affect a company's profitability, such as its competitive landscape and its management team.
Overall, ROIC is a valuable tool for investors to use to evaluate a company's profitability and efficiency. However, it is important to use ROIC in conjunction with other metrics to get a complete picture of a company's financial health.