ROE (return on equity) measures how much profit a company earns on its shareholders' money. ROCE (return on capital employed) measures how much operating profit it earns on all long-term money, shareholders' funds plus borrowings. Together they tell you how hard the company's capital works, and how much of the result is powered by debt.
How do I calculate them?
Vikram pulls up the accounts of Kaveri Motors, our fictional vehicle maker. From its balance sheet: shareholders' equity ₹500 crore, borrowings ₹250 crore. From its P&L: operating profit before interest and tax (EBIT) ₹150 crore, net profit ₹100 crore.
| Ratio | Formula | Kaveri Motors | Result |
|---|---|---|---|
| ROE | Net profit ÷ shareholders' equity | 100 ÷ 500 | 20% |
| ROCE | EBIT ÷ (equity + borrowings) | 150 ÷ 750 | 20% |
Read plainly: every ₹100 of the owners' money produced ₹20 of profit this year, and every ₹100 of total capital (owners' plus lenders') produced ₹20 of operating profit. Higher generally means the business converts capital into profit more efficiently; a company that must pour in ever more capital for the same profit is running to stand still.
For Kaveri Motors the two ratios happen to match. They often don't, and the gap is the interesting part.
Why do ROE and ROCE diverge?
Debt. ROE looks only at the shareholders' slice, so borrowing can inflate it; ROCE charges the company for all the capital it uses, so it can't be flattered the same way.
Compare fictional Sundar Textiles: net profit ₹50 crore on equity of just ₹200 crore, a shiny ROE of 25%. But it also carries ₹700 crore of borrowings, and its EBIT is ₹90 crore. Its ROCE is 90 ÷ 900 = 10%.
| Kaveri Motors | Sundar Textiles | |
|---|---|---|
| ROE | 20% | 25% |
| ROCE | 20% | 10% |
| What it means | Returns earned on the business itself | Returns manufactured largely by borrowing |
Sundar Textiles' headline ROE is higher, yet its underlying business earns far less per rupee of capital. Borrowed money is doing the lifting. That works while times are good; when profits dip, the interest bill doesn't. How much borrowing is too much is the subject of what are debt-to-equity and interest coverage.
A useful habit: when ROE is much higher than ROCE, suspect leverage. When both are high and close together, the business itself is doing the work.
What makes these ratios move over time?
- Margins: earning more profit per rupee of sales lifts both ratios. The margin ladder in what are revenue, EBITDA and profit margins feeds directly into them.
- Capital efficiency: producing the same sales with fewer factories, less inventory and faster collections raises returns.
- Retained profits: equity grows every year profits are retained. If profit doesn't grow along with it, ROE drifts down. A sign new money is earning less than old money did.
Consistency matters more than any single reading. One spectacular year can come from a one-off gain; a company that earns solid returns on capital for five to ten years is demonstrating something structural.
Things to keep in mind
- Compare ROE and ROCE within an industry and against the company's own history; capital-heavy industries naturally run lower than asset-light ones.
- A high ROE with a much lower ROCE usually means debt, not brilliance. Always read the two together.
- One-off gains and write-offs distort a single year; look at multi-year averages.
- A high return ratio describes the business, not the share price. Paying too much for a great business is still a way to get a poor outcome.
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