Return on Total Capital

Return on total capital is a profitability ratio that measures profit earned by a company using both its debt and equity capital. It is also known as return on invested capital (ROIC) or return on capital employed (ROCE).

Return on common equity ratio is normally used to assess profitability. However, there are situations when a company's leverage (i.e. its debt level) artificially magnifies its profitability. In such situations, it is useful to find dollars earned per unit of dollar employed (regardless of it being a debt dollar or equity dollar). This can be achieved by employing either the return on assets ratio or return on total capital ratio. Return on total capital is more refined than return on assets in that it takes into account only such capital for which the company bears a cost.

A higher return on total capital ratio is better.

Formula

Return on Total Capital =Earnings Before Interest and Taxes
Total Capital

Total Capital = Short-term Debt + Long-term Debt + Shareholders' Equity

EBIT is used in numerator because interest is a return on debt and should be included in the measure of profit for this particular purpose. Using net income in this situation would mean including only the profit earned by equity in the calculation.

Example

Extract of relevant financial data from Nike Inc. (NYSE: NKE) financial statements for 2013 is given below:

USD in Million
EBIT2,862
Short-term debt178
Long-term debt1,210
Shareholders' equity11,156

Required: Calculate return on total capital.

Solution

Return on Total Capital =2,862= 22.8%
178 + 1,210+ 11,156

It means that Nike earned $22.8 per $100 of debt and equity.

Written by Obaidullah Jan