Ask how much profit the business earns after tax for every ₹100 it has tied up in operations. Then compare that return with what lenders and owners expect for supplying the money. Growth helps when the extra investment earns enough to cover that cost.
ROIC = after-tax operating profit ÷ average invested capital
ROIC measures after-tax operating profit per rupee tied up in the operations. Use an operating profit measure before financing costs. Include the operating capital supporting that profit, typically on an average basis. Compare the return with the cost of capital and check whether unusual items distort either part. An operating business earns ₹12 crore after tax on ₹100 crore of average invested capital. ROIC is 12%.
An operating business earns ₹12 crore after tax on ₹100 crore of average invested capital. ROIC is 12%.
ROIC measures after-tax operating profit per rupee tied up in the operations. Use an operating profit measure before financing costs. Include the operating capital supporting that profit, typically on an average basis. Compare the return with the cost of capital and check whether unusual items distort either part. An operating business earns ₹12 crore after tax on ₹100 crore of average invested capital. ROIC is 12%.
Which belongs in a basic ROIC numerator?
Full lesson guide
How the idea works
ROIC measures after-tax operating profit per rupee tied up in the operations. Use an operating profit measure before financing costs. Include the operating capital supporting that profit, typically on an average basis. Compare the return with the cost of capital and check whether unusual items distort either part.
Invested capital
Money tied up in the assets and working balances needed to run the business.
Capital charge
The required return multiplied by the capital used.
Apply it to a decision
Fictional example · Check whether a plant expansion earns its cost
A project adds ₹18 crore of operating profit before tax on ₹150 crore of average invested capital. Assume a 25% tax rate and a 10% cost of capital.
Does the project earn its cost of capital in this year?
Set up the problem. After-tax operating profit is ₹18 × 75% = ₹13.5 crore.
Work it out. ROIC is ₹13.5 ÷ ₹150 = 9%. The cost of capital in rupees is ₹150 × 10% = ₹15 crore.
Read the result. The project falls ₹1.5 crore short of its capital charge this year. Forecast the rest of its life before making an investment decision.
Before you use it
Compare operating profit after tax and operating capital using a consistent scope.
Common mistake. Using net income in the numerator mixes financing costs into an operating return.
Compare what the operations earn with the capital they use.
Formula or rule
ROIC = after-tax operating profit ÷ average invested capital
ROIC measures after-tax operating profit per rupee tied up in the operations. Use an operating profit measure before financing costs. Include the operating capital supporting that profit, typically on an average basis. Compare the return with the cost of capital and check whether unusual items distort either part. An operating business earns ₹12 crore after tax on ₹100 crore of average invested capital. ROIC is 12%.
How to approach it
Compare operating profit after tax and operating capital using a consistent scope.
Common mistake
Using net income in the numerator mixes financing costs into an operating return.
Interview recall prompt
Why can a business destroy value by growing even if sales increase?