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Definition of Return on Invested Capital (ROIC)
- Return on invested capital is a method of calculation in which you measure the performance of a company in terms of profitability.
- The ROIC is expressed in terms of percentages.
- The ratio also helps you understand how efficient a company is at utilizing its capital to generate returns.
- The more income generated from the investment, the more efficient the company is.
- The ROIC is often benchmarked with other companies in the market.
What is the formula for ROIC?
- To find the ROIC, you divide NOPAT by Invested Capital.
NOPAT ÷ Invested Capital
- The NOPAT is the net operating profit after tax.
- NOPAT can be calculated through the following formula:
EBIT x (1 – tax rate)
- EBIT is the earnings before interest and tax.
ROIC in Practice
- Tony wanted to open up a shop that sells shoes. Tony’s initial investment was $250,000. Tony’s shoe shop brings in a revenue of $100,000 and has expenses totaling to $40,000. The tax rate is 25%. What would the ROIC be?
- 100,000 – 40,000 = $60,000
- 60,000 x (0.25) = $15,000
- 60,000 – 15,000 = $45,000
- 45,000 ÷ 250,000 = 0.18
- 0.18 x 100 = 18%
- Therefore, Tony’s shoe shop has a ROIC of 18%.
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