The FHR is a highly robust and analytical report that can contain a plethora of information, ratios, and terminology. Although the goal of the FHR is to provide this data in a way that is easily digestible for everyone, there are some advanced financial concepts that are mentioned in the ratings assessment such as the Return on Capital Employed (ROCE) and Free Cash Flow (FCF).
This quick guide will define these concepts and provide some additional commentary regarding their calculations.
What is “Free Cash Flow” (FCF) and What Does the FCF to Total Debt Ratio Tell Us?
Free Cash Flow (FCF) represents cash generated by your company, after covering operating and capital expenses. Total debt includes a company’s short-term and long-term debts. A higher ratio of FCF to Total Debt signals that your company has a better ability to manage debt obligations with available cash.
What is “Return on Capital Employed” (ROCE)?
Return on Capital Employed (ROCE) is a key financial metric that provides insights into how efficiently a company is utilizing its capital. The return on capital employed (ROCE) metric answers the question of, “How much in profits does the company generate for each dollar in capital employed?
Understanding ROCE is valuable for investors and stakeholders as it provides a clear picture of how well a company is managing its resources to create value.
Components of Return on Capital Employed (ROCE)
- Net Operating Profit After Tax (NOPAT): this is a crucial component of ROCE, representing the company's operating profit after adjusting for taxes. It reflects the core profitability of the company's operations.
- Capital Employed: this component is the total capital invested in a company's operations. It includes both shareholder equity and long-term debt, as well as deferred tax. This combination offers a comprehensive view of the financial resources employed to drive business activities.
Calculating Return on Capital Employed (ROCE)
To calculate ROCE, divide NOPAT by Capital Employed and then multiply the result by 100 to express it as a percentage. This percentage indicates the efficiency of the company in generating profits from its invested capital.
(NOPAT/Capital Employed x 100 = ROCE as a %)
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