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ROCE and performance ratios for companies

Edexcel IAL Accounting · WAC12 Corporate and Management Accounting

Return on capital employed is the key measure of how well a company uses its long-term funds. WAC12 also expects the profitability, liquidity and efficiency ratios from Unit 1, applied to companies and used to evaluate performance.

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ROCE for a company

The specification's formula:

ROCE = profit before interest (and tax) / (issued shares + reserves + non-current liabilities) x 100

Profit before interest: add back debenture and loan interest (and tax, if you start from profit after tax).
Capital employed includes non-current liabilities, because the profit added back is before the interest paid to those lenders.

Compare ROCE with the interest rate on borrowing and with other companies; a ROCE below the cost of borrowing suggests capital could be better used.

Ratio (Unit 1)	Formula
Gross profit margin	Gross profit / revenue x 100
Profit margin (net)	Profit from operations / revenue x 100
Mark-up	Gross profit / cost of sales x 100
Current ratio	Current assets / current liabilities : 1
Liquid (acid test) ratio	(Current assets - inventory) / current liabilities : 1
Inventory turnover	Cost of sales / average inventory (times)
Trade receivables collection period	Trade receivables / credit sales x 365 (days)
Trade payables payment period	Trade payables / credit purchases x 365 (days)
Non-current asset turnover	Revenue / non-current assets (times)

Evaluating performance

A good evaluation:

calculates the ratios accurately, with units
compares them: with last year, with a competitor, with industry averages or with targets
explains causes (higher prices, cheaper suppliers, falling sales volume, slower-paying customers)
considers limitations: ratios use historic figures, different accounting policies, year-end figures may not be typical, inflation, and non-financial factors are ignored
concludes with a judgement applied to the company in the question.

Example

Profit after interest and tax £4,200,000; tax £800,000; debenture interest £1,500,000; bank loan interest £500,000. Issued shares and reserves £42,000,000; non-current liabilities £30,000,000.

Profit before interest and tax = 4,200,000 + 800,000 + 1,500,000 + 500,000 = £7,000,000

Capital employed = 42,000,000 + 30,000,000 = £72,000,000

ROCE = 7,000,000 / 72,000,000 x 100 = 9.72% (this mirrors the June 2022 mark scheme).

Worked example

A company has revenue £8,000,000, gross profit £3,200,000 and profit from operations £960,000. Last year the margins were 42% and 14%. Calculate this year's margins and comment.

Gross margin = 3,200,000 / 8,000,000 x 100 = 40.0%
Profit margin = 960,000 / 8,000,000 x 100 = 12.0%
Both margins have fallen: the gross margin by 2 points (higher purchase costs or price cuts) and the profit margin by 2 points, so expenses have kept pace with revenue

Answer: Gross margin 40.0%, profit margin 12.0%: profitability has weakened

Key idea: ROCE = profit before interest / (issued shares + reserves + non-current liabilities) x 100. Use Unit 1 ratios too, and evaluate with comparisons, causes, limitations and a conclusion.

Check yourself

Profit before interest and tax £2,700,000; issued shares £10,000,000; reserves £6,000,000; non-current liabilities £4,000,000. Calculate ROCE to 2 decimal places.
Show answer
13.50 %. 2,700,000 / 20,000,000 x 100 = 13.50%.
Profit after tax is £1,400,000, tax is £350,000 and debenture interest is £250,000. Calculate profit before interest and tax.
Show answer
£2000000. 1,400,000 + 350,000 + 250,000 = £2,000,000.
Current assets £860,000 including inventory £340,000; current liabilities £400,000. Calculate the liquid (acid test) ratio to 2 decimal places.
Show answer
1.30 : 1. 520,000 / 400,000 = 1.30 : 1.
Trade receivables are £246,000 and credit sales are £1,825,000. Calculate the trade receivables collection period in days, to the nearest day.
Show answer
49 days. 246,000 / 1,825,000 x 365 = 49.2, so 49 days.
Revenue £5,400,000 and cost of sales £3,510,000. Calculate the gross profit margin to 1 decimal place.
Show answer
35.0 %. Gross profit = 1,890,000; 1,890,000 / 5,400,000 x 100 = 35.0%.
Why are non-current liabilities included in capital employed for ROCE?
- Because they are owned by shareholders
- Because the profit figure used is before the interest paid on them
- Because they are current
- Because tax is charged on them
Show answer
Because the profit figure used is before the interest paid on them. The numerator includes the return to lenders, so the denominator must include the lenders' capital.
Which is a limitation of using ratios to compare two companies?
- Ratios cannot be calculated for public companies
- Ratios always use forecast figures
- Ratios include all non-financial factors
- They may use different accounting policies, such as depreciation methods
Show answer
They may use different accounting policies, such as depreciation methods. Different policies change the figures used.

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Last updated 8 November 2026. Spotted a mistake? Tell us.