ankitgokani
Ankit Gokani
Return on Invested Capital or ROIC is an instrument that can be used for measuring the historical performance of a business unit or of an entire company.
Discounted Cash Flow ultimately drives the (future) value of any company (leading indicator). However, short-term cash flow results are not good for performance measuring, because cash-flows are easy to manipulate, for example by delaying capital spending, postponing advertising campaigns or decreasing R&D levels. ROIC is a lagging indicator; it provides information on how a company has performed in the past.
The ROIC model is often used to assess the value creation capabilities of a firm or firms in an intuitive way. High (relative) ROIC levels are seen as proof of a strong company and/or solid company management. However great care should be taken. An unbalanced focus on the method ROIC may just as well be an indicator of poor management due to harvesting behavior, ignoring growth possibilities, and long-term value destruction. Since Return on Invested Capital is an accounting-based measure, it suffers the following concerns:
- manipulability by management,
- influenced by accounting conventions and by changes in accounting conventions, and
- affected by inflation and currency exchange movements.
What can be said is that companies earning less than their Cost of Capital usually can't create value by growing alone, unless their Return on Invested Capital moves up above the Cost of Capital (WACC).
Calculation ROIC
A simple ROIC formula = Net Income After Tax = After Tax Operating Earnings
Invested Capital Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities
Even more adequately, ROIC for a single time period = Net Operating Earnings before Interest and Amortization Charges, but after Cash Taxes
Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities
Discounted Cash Flow ultimately drives the (future) value of any company (leading indicator). However, short-term cash flow results are not good for performance measuring, because cash-flows are easy to manipulate, for example by delaying capital spending, postponing advertising campaigns or decreasing R&D levels. ROIC is a lagging indicator; it provides information on how a company has performed in the past.
The ROIC model is often used to assess the value creation capabilities of a firm or firms in an intuitive way. High (relative) ROIC levels are seen as proof of a strong company and/or solid company management. However great care should be taken. An unbalanced focus on the method ROIC may just as well be an indicator of poor management due to harvesting behavior, ignoring growth possibilities, and long-term value destruction. Since Return on Invested Capital is an accounting-based measure, it suffers the following concerns:
- manipulability by management,
- influenced by accounting conventions and by changes in accounting conventions, and
- affected by inflation and currency exchange movements.
What can be said is that companies earning less than their Cost of Capital usually can't create value by growing alone, unless their Return on Invested Capital moves up above the Cost of Capital (WACC).
Calculation ROIC
A simple ROIC formula = Net Income After Tax = After Tax Operating Earnings
Invested Capital Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities
Even more adequately, ROIC for a single time period = Net Operating Earnings before Interest and Amortization Charges, but after Cash Taxes
Total Assets - Excess Cash - Non-Interest-Bearing Current Liabilities