1. Return on Invested Capital and Profitability Analysis
Week 13
Abdullah Al Shukaili

2. Learning objectives Computing Return on Invested Capital
Analyzing Return on Net Operating Asset
Analyzing Return on Common Equity

3. Return on invested capital
Financial statement analysis involves assessing both risk and return
Return on invested capital refers to
a company’s earnings relative to both the level and source of financing.
It is a measure of a company’s success in using financing to generate profits

4. Importance of Return on investment
We can analyze company performance in several ways.
Revenue, net income, and asset growth
There is also another measure for the performance called return on invested capital (ROIC)
The relation between income and invested capital, referred to as return on invested capital (ROIC) or return on investment (ROI)
ROI is probably the most widely recognized measure of company performance

5. Importance of Return on investment
ROI is the basic profitability ratio.
This ratio establishes relationship between net profit (before interest, tax and dividend) and capital employed.
It is expressed as a percentage on investment.
The term investment here refers to long-term funds invested in business.
This investment is called capital employed.

6. Capital Employed Capital employed =
Equity share capital + preference share capital + Reserve and surplus + long term liabilities

8. ROI Used to compare companies on their success with invested capital.
It allows us to assess a company’s return relative to its capital investment risk, and
we can compare the return on invested capital to returns of alternative investments.

9. ROI
It determines a company’s ability to succeed, attract financing, repay creditors, and reward owners.
We use return on invested capital in several areas of our analysis including: (1) managerial effectiveness, (2) level of profitability, and (3) planning and control.

10. ROI computation
Return on invested capital ( ROI) is computed as:

11. When ROI is good?
ROI measures how efficiently the sources of the business are being used.
In other words, it tells what is the earning capacity of the net assets of the business.
Higher the ratio the more efficient is the management and utilization of capital employed.

14. Exercises For Excel Cooperation Required find :-
EBIT in year 2008 = 163,005
Total S/H equity in year = 668,305
Total common stock = 413,783
Long term debt = 507,329
Required find :-
Return on investment ( ROI)
Return on common equity ( ROCE)

15. Exercises ROI = ( EBIT / Invested Capital ) * 100
= {163,005 / (668, ,329 )} * 100
= {163,005 / 1,175,634} * 100 = %
This means that the company’s efficiency to generate a return from its invested capital is 13.8 %

16. Return on common equity (ROCE)
(ROCE) is defined as :-
(Net income - preferred dividends) /
average common equity.
Common equity is equal to :-
Total shareholders’ equity - preferred stock.
Preferred stock is excluded from the computation since, from the viewpoint of common shareholders, preferred stock has a fixed claim to the net assets and cash flow of the company, just like debt.