The FHR Report includes two advanced financial ratios that are worth a closer look: Return on Capital Employed (ROCE) and Free Cash Flow to Total Cash Expenditure (FCF to TCE). This article defines each ratio, explains how it is calculated, and describes what a higher or lower value signals about a company's financial health.
What is Return on Capital Employed (ROCE)?
Return on Capital Employed (ROCE) measures how efficiently a company generates profit from the capital it has invested in operations. It answers the question: how much operating profit does the company produce for each dollar of capital employed?
A higher ROCE indicates that a company is converting its invested capital into profit more efficiently. Investors, lenders, and procurement teams use ROCE to compare operational efficiency across companies and across time.
Components of ROCE
ROCE has two inputs:
Operating Profit: the profit a company earns from its core business operations, before interest and tax. This reflects the underlying profitability of the business, independent of how it is financed or taxed.
Capital Employed: the total capital invested in the company's operations. This includes shareholder equity, total debt, and deferred tax, giving a comprehensive view of the financial resources used to run the business.
How ROCE is calculated
Divide Operating Profit by Capital Employed, then multiply by 100 to express the result as a percentage:
ROCE (%) = (Operating Profit / Capital Employed) × 100
The resulting percentage shows how much operating profit the company generates for every dollar of capital it has deployed.
What is Free Cash Flow (FCF)?
Free Cash Flow (FCF) is the cash a company generates after covering its operating expenses and capital expenditures. It represents the cash available to repay debt, reinvest in the business, or return to shareholders.
What does the FCF to Total Cash Expenditure ratio tell us?
The FCF to Total Cash Expenditure ratio compares the cash a company generates against the total cash it is spending. It is a measure of self-funding: it shows how much of the company's total cash outflow is being covered by the cash the business itself produces.
A higher ratio indicates that the company is funding more of its own expenditure from internally generated cash and relying less on external financing. A lower ratio indicates that the company is covering a larger share of its spending through debt, equity, or cash reserves.
How FCF to Total Cash Expenditure is calculated
Divide Free Cash Flow by Total Cash Expenditure, then multiply by 100 to express the result as a percentage:
FCF to Total Cash Expenditure (%) = (Free Cash Flow / Total Cash Expenditure) × 100
Why these ratios appear in the FHR
Both ratios feed into the broader FHR assessment because they capture two distinct dimensions of financial health:
ROCE measures how productively a company uses the capital it has.
FCF to Total Cash Expenditure measures how sustainably a company funds its own activity.
Read together, they help explain whether a company is both efficient with its capital base and capable of financing itself from operations.