Treasury Practice

Return on Invested Capital (ROIC)

Published: Jul 2006

Return on Invested Capital (ROIC) is a measure of the performance of a business unit or of an entire company. Investors use the ratio to assess the quality of company returns. ROIC is an important ratio because, more significantly than profit margins or simple growth figures, it computes how much cash can be produced for a given cash investment. ROIC makes no distinction between equity shareholders and lenders for the cash-on-cash return, and effectively measures how much value a company’s operations actually create.

The simple equation for ROIC is:

\(\frac{Net\: Income\: After \:Tax}{Invested\: Capital}\)

The difficulty in calculating ROIC is that it requires several adjustments to be made from the financial statements, all of which aim to represent the company’s operations more effectively. Some companies may receive income from sources other than their operations, for example investment income. Therefore net operating profit after tax (NOPAT) is often used instead of net income after tax.


While for some companies NOPAT may be equivalent to the net income after tax, other companies may need to make adjustments to exclude investment and interest income, while including the tax paid on these items. The tax shield from interest expenses must be subtracted and goodwill amortisation and nonrecurring costs may or may not be added, depending on the method used.

We start with earnings before interest and taxes (EBIT) or, if this is not reported, with earnings before taxes, and add back any interest expenses, because it is necessary to capture the profits that accrue to all capital holders including lenders. Amortisation of goodwill is also added if goodwill is included in depreciation charges of revenue/net sales.

It is worth noting that depending on the company and method used, more complex adjustments – which are beyond the scope of this article – can be made for operating leases, inventory accounting etc. to convert accrual into a more cash-based profit figure.

Operating taxes need to be subtracted from this figure to give us net operating profits after taxes:

\(NOPAT={Operating\: Income}\times{\:1\:–\:Tax\: Rate}\)

Invested Capital

The invested capital is calculated as total assets less excess cash, less non-interest-bearing current liabilities. Cash is deducted as it is not invested in the business. Non-interest bearing current liabilities (NIBCL) is a type of debt that must be paid within one year, but which does not require interest payments, for example accounts payable or deferred taxes. As NIBCL represents a free source of credit which ultimately enhances returns, it should be reflected in ROIC. NIBCL are therefore deducted from total assets.

This gives us the following equation:

\(ROIC=\frac{Net\: Operating \:Earning\:–\:Cash \:Taxes\:+\:Interest\: and\: Amortisation\: Charges}{Total\: Assets\:–\:Excess\: Cash\:–\:Non-Interest-Bearing\: Liabilities}\)

ROIC-WACC spread

ROIC in itself is not able to give any indication as to whether a company’s operations are creating sufficient value. In order to give a proper assessment, the return on the invested capital has to be compared to the cost of capital. ROIC is compared to the weighted average cost of capital (WACC). Only if ROIC exceeds WACC, and the so-called ROICC-WACC spread measured is positive, have the company’s operations generated value from the invested capital.

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