Accounting is full of acronyms. ROCE & RONA for example. To dispel any confusion between these two ratios for measuring an organisation’s performance, let’s examine the differences.
Let’s start with what they stand for.
- ROCE is Return on Capital Employed
- RONA is Return on Net Assets
They’re both indicators used to measure efficiency and profitability. Both use the profit from operations figure in their calculation, because both give an indication of how well an organisation’s resources are being used to generate profit.
So, what’s the difference?
Well the honest answer is that it’s subtle but significant.
It’s how the organisation’s resources are calculated. If we look at the calculations, we can see both the similarities and the difference:
- Profit from operations ÷ capital employed x 100 = ROCE
- Profit from operations ÷ net assets x 100 = RONA
Therefore, we need to think about the preliminary calculations of capital employed and of net assets, because they’re the source of the distinction.
Capital employed and net asset figures
Capital employed is the money used to run an organisation. It not only includes owners’ capital and retained earnings, but also any money available as a result of borrowing.
It can be calculated as:*
- Total equity (owners’ capital) + non-current liabilities (loans etc)
In contrast, an organisation’s net assets are everything it owns, less everything it owes, in both the short and long term:
- Total assets – total liabilities = net assets (total equity)
Net assets are the same as total equity, in other words, the amount the organisation owes its owners’.
It’s the accounting equation that we learnt back at Foundation level and the reason why the net assets figure on the statement of financial position (SoFP) reconciles with the total of the ‘financed by’ section.
It’s also the key to understanding the difference between ROCE and RONA, which is that the ROCE calculation includes non-current liabilities.
ROCE includes non-current liabilities
Let’s see how it works and what it means.
Below is some key data taken from the financial statements of two organisations, which both operate in the construction industry, for the year ending November 2019:
If we analyse the information at face value, then B Limited is a more profitable company than A Limited, judged on both sales revenue and operating profit. But is that right?
The data suggests so, but it’s not quite that simple because B Limited also has significantly more assets than A Limited, and substantially more long term borrowing as well.
The raw data isn’t easily comparable, so ROCE and RONA can be used to help as they’re calculated as percentages.
Comparing via RONA
Let’s first see how well both companies are using their assets to their economic advantage, in other words, how much they earnt from every pound invested in assets.
This is assessed by RONA and the higher the ratio the better:
Whilst B Limited is arguably the more valuable organisation as it has the most net assets, the Return on Net Assets show that A Limited is the more efficient one. This is because it’s generating 70p of profit for every £1 it has invested in assets, whereas B Limited is only returning 23p.
However, this is not the full story either, because the reality is that both organisations have more resources at their disposal than the net assets that they own.
They both have long term borrowing or loans which is evidenced by the non-current liabilities figures.
Comparing via ROCE
As the capital employed includes borrowing, the ROCE’s provide a similar comparison of how well each organisation is generating profit but this time the calculation is based on the amount of capital used:
B Limited has more capital to employ than A Limited.
This is because it has more assets, which is the same equity, than A Ltd as we have already noted, plus it has higher borrowing.
However, the ROCE’s confirm the same findings as the RONA’s, which is that A Limited is the more efficient company when it comes to generating profits through the deployment of its resources.
It uses it’s £8.7 million capital to generate a 44% return, which is 28% more than B Limited generates from the £90 million it has at its disposal.
Now we have a clearer, more comparable, picture of these two organisations’ performance, if I were to ask you which is the most profitable, would you be able to give me an answer?
I hope so. But I also hope it wouldn’t be a simple case of one or the other, because the truth is that a range of indicators are required to give a comprehensive view of any organisation’s performance.
From what we know in this case though, I think it would be fair to say that whilst B Limited generated more operating profit than A Limited, and had more assets and capital at its disposal, A Limited used its resources more profitably.
* Capital employed can also be calculated as Working capital (current assets – current liabilities) + non-current assets and it can be useful to be familiar with both calculations so that the figure can be double checked. However, when ROCE is being compared to RONA, the calculation given is easier to understand.
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Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.