Return on capital employed

At the enterprise level, the executive management responds to the voice of ownership and is primarily concerned with profit, return on capital employed, market share, etc. At the business level, the managers are concerned with products and services and hence respond to the voice of the customer. At the operational level, the middle managers, supervisors, operators, etc. focus on processes that produce products and services and hence respond to the voice of the processes carried out within their own function. 

Any presentation to the organization s senior management, besides giving the technical details, should include a financial appraisal, which could be on a simple payback basis. However, other methods are available, such as return on capital employed and discounted cash flow (DCF). 

Return on capital employed can be expressed in four ways ... 

Ratios well below 1 may indicate financial problems ahead while those substantially greater than 1 may point to poor credit control or under-utilization of cash. This ratio is sometimes known as the acid test . The principal profitability ratio in use is the net profit before interest and tax (NPBIT) to net assets or return on capital employed. 

The most widely used gage of profitability is the ratio of profit to net assets (or return on capital employed) ... 

The EVA [10,11] combines information from the profit and loss statement (revenue, costs, earnings before interests and taxes (EBIT), etc.) and the financial sheet (net working capital (NWC), assets, etc.). The EVA is the interest calculation in absolute measurements and strongly related to the return on capital employed (ROCE) where the gained interest rate is calculated (Figure 1.7). In the long term, this interest rate should be above the capital costs of the company which is the interest rate the company has to pay for a credit on the capital market. Hence, a positive EVA means that the company has earned some money above the capital costs. 

Value-oriented management concepts evolved from cost and profit controlling towards value based management concepts. Transparency on profitability of invested capital for the company and its shareholders is an objective of value-based management. Profitability indicators are related to capital indicators. Common indicators are Return on Assets (ROA), Return on Capital Employed (ROCE) and Economic Value Added (EVA ) as presented in table 3 (Hostettler 2002 Revsine et al. 2004). 

Return on investment (ROl), Return on Capital Employed (ROCE) and Internal Rate of Return (IRR) are terms all referring to the profitability of a project or product in terms of the original investment made, i.e. ... 

The reward criterion covers those areas related to the expected financial performance of the project. An important method for determining the financial success of a project is the net present value (NPV) calculation. This method calculates the present value of future cash flows. If the NPV is positive, the investment is beneficial from a financial standpoint. Additionally, a financially successful project is expected to have an average return on capital employed (ROCE) above a selected level, which makes commercial sense with regards to industry/branch standards. 

The project team must detail all past costs that the project has incurred since its inception (start of EvP) on an annual basis. In addition, an annual project financial information table (ProFIT) data sheet should be presented. This sheet contains the revenue and cost forecasts for the upcoming ten-year period. It computes net present value (NPV) of future cash flows and return on capital employed (ROCE) automatically. At this stage, the team is expected to include detailed production costs data as well as estimates of plant costs (based on an engineering estimate, for example). The ten-year projection should be provided for three scenarios base, optimistic, and pessimistic. These cases are not meant to be simple percentage changes of the sales projections. Instead, the team should try to identify the drivers of the project s success and construct alternatives for the future that lead to different results for the project. The base case should be the most likely case. The optimistic scenario should be based on the positive development of some (not all) key success factors. The pessimistic scenario is usually the minimum feasible case, meaning a situation where the organization would still prusue the project, but some factors do not develop in a positive way. 

The procedure is different for multinational companies with scarcely more than an importing or marketing subsidiary in the United Kingdom. The PPRS attempts to apply the same standards to these companies however, much of the information regarding a multinational company s expenses would not be applicable to the United Kingdom, so an allowed rate of return on sales is used instead of a return on capital employed (44,84). 

The UK Department of Health negotiates with companies a maximum rate of return on capital employed in their sales to the National Health Service. An overall rate is fixed for the industry as a whole and within this figure an indivi dual firm is awarded a particular rate having regard to the scale and nature of the company s relevant investments and activities and the associated long-term risks . The system may perhaps have to be changed because of EC legislation. 

Gross margin, return on capital employed (ROCE)... 

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