ROIC: Understanding Return on Invested Capital & Its Significance

Return on invested capital (ROIC) is a common measure for financial management. It is the percentage of revenue based on the investments made for a certain project. So long as return on invested capital is greater than the weighted average cost of capital, then the project is worth its salt and will be profitable, if all goes to plan.

Calculating ROIC

The calculation of ROIC involves first obtaining the net operating income, essentially earnings before interest and after taxes. It is also known as net operating profit after taxes (NOPAT). This figure gives a clear operating net income figure from a standpoint of operations only and no financial gain.

The denominator is made up of the operating capital that was used to generate revenue for the company. This is obtained from the statement of cash flows; line item, capital expenditures. So, ROIC measures project by project and maintains the benchmark to compare to the weighted average cost of capital, which is simply the cost of the capital borrowed to obtain the project machinery for revenue.

The value of ROIC is calculated as a percentage. This is commonly used by upper level management in making a decision of whether or not to pursue a project.