Return on invested capital (ROIC)

The formula

• ROIC = 100 · N / K

N is the operating profit after tax, NOPAT, and K the invested capital: the equity plus the interest-bearing debt, or equally the assets the operation needs less the liabilities that carry no interest. The percentage is what the capital tied up in the business earned, before the question of who provided it.

A worked example

A company has an operating profit of 120,000, pays 25% tax on it and so keeps a NOPAT of 90,000; its invested capital is 1,000,000: ROIC = 100 · 90,000 / 1,000,000 = 9%. The same NOPAT on 1,500,000 of capital would be 6%.

NOPAT, not net income

ROIC asks what the operation earns for everyone who financed it, so interest is not taken off: the lenders’ return is part of the answer. Tax is taken off, since nobody gets it. NOPAT = EBIT × (1 − tax rate). Net income, which is after interest, belongs in ROE.

The comparison that gives it meaning

ROIC is read against the cost of the capital, the return lenders and owners together require. A business earning 9% on capital that costs 7% creates value as it grows; one earning 5% on the same capital destroys it however fast it grows. The gap, not the ROIC alone, is the figure to look at.

Common mistakes

• Taking profit after interest. That removes the lenders’ share from the numerator while their capital stays in the denominator.
• Counting cash that the operation does not need. Surplus cash in K lowers the ROIC of a business that is doing fine.
• Using the tax actually paid in a year with one-offs. A normal tax rate on EBIT is what the formula wants.

Frequently asked questions