Return on invested capital (ROIC) or return on investment (ROI)

compare companies on their success with invested capital (used to assess a

company's efficiency at allocating the capital under its control to profitable
investments).
ROIC gives a sense of how well a company is using its capital to generate profits.
assess a company’s return relative to its capital investment risk
compare the return on invested capital to returns of alternative investments
Riskier investments are expected to yield higher returns
A ROIC higher than the cost of capital means a company is healthy and growing, while an
ROIC lower than the cost of capital suggests an unsustainable business model.
assesses a company's efficiency at allocating the capital under its control to profitable
investments or projects. The ROIC ratio gives a sense of how well a company is using the
money it has raised externally to generate returns.

Analysis of return on invested capital compares a company’s income, or other

performance measure, to the company’s level and source of financing
determines a company’s ability to succeed, attract financing, repay creditors, and
reward owners
used in several areas:
1. managerial effectiveness, depends primarily on the skill,
resourcefulness, ingenuity, and motivation of management.
Management is responsible for a company’s business activities.
2. level of profitability, important indicator of a company’s long-
term financial strength, It can effectively convey the return on
invested capital from varying perspectives of different
financing contributors (creditors and shareholders).
3. planning and control. is composed of the returns (and losses)
achieved by the company’s segments or divisions.
Income Income
Return on invested capital= =
Invested capital Average Invested Capital

2 measures to which is linked a different meaning of invested capital, as no universal

measure of invested capital from which to compute rate of return
Net Operating Assets Common Equity Capital
 RNOA=
NOPAT
Common Equity Capital=
[ ( Net Income )−( Preferred Div
NOA Average Common Equi
Many analysts segregate the balance sheet and income
statements into operating (operating activities are the most the amount that all common shareholders have
long-lasting and relevant for the determination of stock price) invested in a company
and nonoperating components and compute a return on net
operating assets (RNOA) Common equity =
captures the return on the company's Assets that are (Total Shareholders’ Equity)−(Preferred Stock )
generating Revenue. Or
Operating activities are the core activities of the company. Total Assets−[ ( Debt ) +( Preferred Stock)]
Analyze a company along this operating/nonoperating The amount of equity in the capital structure, and
dimension, with the return on net operating assets (RNOA) as thus the amount of equity used in the computation
the summary measure of performance. of return on equity, is, therefore, a function of the
degree to which the company is financed with
Operating Activities debt (that is, more debt means less equity)
In the income statement In the balance sheet
sales, cost of goods sold, assets and liabilities relating
and selling and general and to these income statement
administrative (SG&A) accounts such as accounts
expenses receivable, inventories, PPE,
accounts payable, and
accrued expenses.

NOPAT = net operating income after tax>

Revenues - Operating Expenses such as cost of goods sold,
SG&A expenses, and taxes
NOA = net operating assets>
Operating Assets (Total Assets - Financial Assets) –
Operating Liabilities (Total Liabilities - Interest-bearing
debt)

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Return on Net Operating Assets (RNOA)
Net operating profit after tax NOPAT
RNOA=
Average net operating assets NOA
NOA=( Operating Assets ) −( Operating Liabilities )
Operating assets and liabilities are those necessary to conduct the company’s business, and they
include cash, accounts receivable, inventories, prepaid expenses, deferred tax assets, property, plant,
and equipment (PPE), and long-term investments related to strategic acquisitions (such as equity
method investments, goodwill, and acquired intangible assets.
Netted from these operating assets are current operating liabilities, such as accounts payable and
accrued expenses, and long term operating liabilities, such as pensions and other postretirement
(OPEB) liabilities and deferred income tax liabilities.
Net financial obligations (NFO) is equal to ( Nonoperating Liabilities )−(Nonoperating Assets)

financial obligations financial assets

notes and other debt payable and dividends payable short-term and long-term investments in marketable
securities

Represent the balance sheet with the following operating-based and non-operating based identity

Net operating assets (NOA) = Net financial obligations (NFO) + Stockholders’ equity (SE)

The numerator of the RNOA equation, net operating profit after tax (NOPAT), is
the after-tax profit earned from net operating assets.
shows how well a company performed through its core operations, net of taxes. 
NOPAT =Revenues−Operating Expenses

NOPAT =( Sales−Operating expenses )∗ 1−

( [ Tax expense
Pretax profit ])
Return on net operating assets = (Net operating profit margin) * (Net operating asset
turnover)
NOPAT
∗Sales
NOPAT Sales
=
Average NOA Average NOA

NOPAT-to-sales relation is called net operating profit margin = NOPAT

margin> measures a company’s operating profitability relative to sales
sales-to-NOA relation is called the net operating asset turnover = NOA
turnover> measures a company’s effectiveness in generating sales from net operating
assets.
Net operating assets (NOA) are reduced by increases in operating liabilities, thus increasing net
operating asset turnover.
increase in operating liabilities does not affect NOPAT, RNOA is also increased
operating liability effect seen in decomposition:
NOPAT
∗Sales
NOPAT Sales
= ∗(1+OLLEV )
Average NOA Average NOA
OA is Operating Assets (gross) and OLLEV (Average Operating liabilities/ Average NOA) is the
operating liability leverage ratio
Since OLLEV is a positive number, increasing OLLEV increases RNOA.
The intuition behind the equation is this: operating liabilities generally do not entail a cost if used
judiciously.
NOPAT margin and NOA turnoverare not independent. Profit margin is a function of sales (selling
price % units sold) and operating expenses. Turnover is also a function of sales (sales/assets).
Consequently, increasing profit margin by increasing selling prices impacts units sold.

Disaggregation of Profit Margin

Net operating profit after tax NOPAT
Sales
a function of the per-unit selling price of the product or service compared with the per-unit costs of
bringing that product or service to market and servicing customer needs after the sale.
Gross Margin Selling expense Administration expense R∧D
Pretax sales PM = − − −
Sales Sales Sales Sales
 Gross profit ( ¿ gross margin ) =Revenues−Cost of Sales
All other costs must be covered by gross profit, and
any income earned is the balance remaining after
these costs.
Gross profit must be sufficiently large to finance
essential future-directed discretionary expenditures
Gross profit
Gross profit percent=
Sales
Analyzing changes in sales and cost of sales is useful
in identifying major drivers of gross profit. Changes in
gross profit:
 Increase (decrease) in sales volume.
 Increase (decrease) in unit selling price.
 Increase (decrease) in cost per unit.

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Net Income−Preferred Dividends
ROCE= '
Average Common shareholder s equity
2 components: operating return (RNOA) and nonoperating return (the positive or negative effects
of financial leverage)

Ratio Formula Meaning

Return on Net Operating Net operating profit after tax NOPAT
RNOA=
Average net operating assets NOA
Assets (RNOA)
NOA NOA=( Operating Assets ) −( Operating Liabilities )

Return on Common Equity

(ROCE)