ROTC measures a company’s profitability using all of its available capital. This includes equity financing, such as common stock and preferred stock, plus debt and retained earnings.
To calculate it, you subtract dividends from net income and divide that by total capital. Unlike return on equity, this calculation also includes debt and other non-current liabilities in the denominator.
Return on Invested Capital
Return on invested capital is a key measure of how well a company turns investor funds into profit. It is a simple formula, comparing net operating profit after tax (NOPAT) to invested capital. Investors often use this metric to make comparisons between companies and find which ones are worth investing in.
To calculate ROIC, subtract dividends from net income and divide the result by total invested capital. This metric takes both equity and debt into account. A company is considered to be a value creator when its ROIC is higher than its cost of capital, and a value destroyer when it earns lower than the cost of capital. You can find ROIC on the income statement under Earnings Before Interest and Taxes. If you prefer, you can also use book value of capital instead of market value. The latter may provide a more accurate number for rapidly growing companies. This calculation excludes non-operating assets such as cash and short-term investments.
Return on Equity
A company can raise its return on equity by increasing sales or controlling costs. Controlling expenses is a way to reduce the denominator of the ratio, or lower the cost of goods sold (COGS). Increasing sales can increase the numerator, or profits, through boosting pricing and improving product margins.
The higher a company’s ROIC, the more efficient its management is at turning investor capital into net income. This is because the more profitable a business is, the less it will need to take on new debt or make new investments in its assets, both of which dilute shareholder value. The ROIC calculation takes into account all revenue and profit streams, including those that come from non-sales activities like interest and rental income, which may not show up in the income statement. However, one-time events can also artificially inflate a company’s return on equity. For example, an inventory write-down can temporarily lower the company’s book value and make its ROE look better.
Return on Total Assets
The return on total assets tells management and investors how well a company’s assets are utilized to generate revenues and profits. It is calculated by dividing net income by average total assets. Unlike return on equity, it includes debt in the denominator.
It is typically calculated using the opening and closing balances of a company’s assets for an accounting period and then dividing by two. The formula can be modified to calculate average total assets over a longer period, which could be more helpful if your company’s asset levels are highly variable.
It can be compared to the return on assets of similar companies in the same industry to see how well they are utilizing their assets. This ratio is commonly used by investors, analysts and other stakeholders to evaluate a company’s efficiency in turning assets into net profit. It can also be an important indicator of the efficiency of a particular line of business.
Return on Total Debt
While return on total debt is a good indicator of leverage levels, it should be analyzed along with other ratios such as the debt-to-equity and current ratio. High levels of leverage can impact a business’s financial health, particularly small and mid-sized businesses.
A company’s total debt is a combination of long-term and short-term liabilities. To calculate it, a company must collect all of its long-term and short-term liabilities and add them together. Short-term liabilities are usually credit card debt, utilities and invoices to be paid. Long-term debt includes mortgages and bonds, which are repaid over more than one year.
Return on total debt is less common than other profitability indicators like return on equity and return on invested capital. However, it is an important metric for capital-intensive businesses like brick-and-mortar retailers and telecommunications companies. It is also useful for evaluating companies that have significant amounts of cash on hand. For these companies, it’s important to remove cash from the net working capital calculation since this isn’t considered an invested capital.