Our current quest is to determine more about the worthiness of our investments by calculating the ROCE (return of capital employed) for a given company. Our main point of reference is Phil Oakley's book "How to pick quality shares". The concept of ROCE itself seems fairly easy to grasp, as defined as follows:
ROCE = EBIT (i.e. Operating Profit) / Capital Employed
I'm struggling however with how exactly to extract the current figures from the co. statements in order calculate the "Capital Employed" figure. The idea of seems reasonable enough - it's like the total of monetary value of what the firm uses to make stuff. So I understand CE in terms on money down which the firm can put to work. We worked through Phil Oakley's book and he says that CE can be calculated using either the asset side or the equity and liability side of the BS. For the asset side he goes on to say:
CE = total assets - current liabilities + short term borrowings
and a condensed view of the assets part of the Domino Pizzas BS says the following:
Non-current assets: 95.7
...
Current assets: 89.7
...
Total assets: 185.4
the current liabilities broken down in more depth:
Trade: [52.9]
Deferred Inc: [4.3]
Financial liabilities: [0.988] *
Deferred contigent consideration: [2.86]
Current tax liab.:[4.15]
Provisions: [6.11]
Current liabilities: [71.3]
Phil then derives the capital employed like this:
So, Domino's total capital employed at the end of 2015 was 185.4m minus 71.3m plus 1m, or 115.1
So we are left guessing that 1m figure was the rounded up value of "Financial liabilities". We puzzled by this (though mainly by Phil not mentioning where 1m figure was hoiked out from!). The other thing which we are troubled by is why Phil uses Total assets (i.e. non-current and current), but for the liabilities only current ones are used (non current ones are elsewhere on the BS).
Can anyone clarity why Phil only uses Current liabilities and why he magics up the 1m?
In another example we managed to dig out Account reports for Marshalls PLC
https://www.marshalls.co.uk/documents/r ... report.pdf
https://www.marshalls.co.uk/documents/r ... esults.pdf
In this case Marshalls had actually calculated their ROCE themselves (and hence the capital employed). However, they had used the "liabilities and equity" side of their BS to do this, which although reasonable, is not something which Mel and I have covered yet! Only attempted the asset and liability side calculation so far....
FWIW, Marshalls publish their "Reported ROCE" as 20.8%, (page 16 of the results.pdf) and state that it is calculated like this:
Reported ROCE is defined as EBITA divided by shareholders funds plus cash / net debt.
(EBITA is given as 54.5m)
So using Marshalls BS (page 74 of the report.pdf) we attempted to derive the Capital Employed figure from the assets and liabities side.
Non-current assets: 249
...
Current assets: 166
...
Total assets: 415
and for the liabilities:
Current liabilities: 106.9
...
Non-current liabilities: 70.9
...
Total liabilities: 177.8
Initially we tried to calculate ROCE, by just using Total Assets, Current liabilities, (could see no explicit reference to short-term borrowings) and EBITA from the BS.
Our result:
ROCE = (54.5) / (415 - 106.9) x 100% = 17.7%which seems too low.
So we retried but instead we subtracted Total liabilities this time the answer seems a bit closer to Marshalls:
ROCE = (54.5) / (415 - 177.8) x 100% = 23.0%which now seems too high - by a similar amount.
Can anyone clarify how we can derive ROCE from the assets side of the BS, and end up with something similar to Marshalls value of 20.8%?
Sorry, appreciate we are asking a lot of questions this time, but really trying to figure this out ourselves from the reports, without "taking for granted" the ready-cooked figures, and hence come up with a figure for any firm using a fairly generic formula.
Many thanks, Matt and Mel
The ROCE calculation is shown in Note 2 "Alternative Performance Measures". The way they calculate ROCE certainly is alternative, I would not use that method and so I would ignore their own figure which is practically useless for comparisons with other companies. I'll stick with ROCE = 17.3%!