What is capital employed?

It is the total long-term finance invested in the business, calculated as total equity plus non-current liabilities.

A firm has operating profit of £120,000, equity of £400,000 and non-current liabilities of £200,000. Calculate its ROCE.

Capital employed is £600,000, so ROCE is £120,000 divided by £600,000 × 100 = 20%.

Why is ROCE compared with the return available on a bank deposit?

The capital could have been left in the bank earning interest at no risk, so a business earning less than that is not rewarding its investors for the risk they are taking.

Why is ROCE regarded as the most important profitability ratio?

It relates profit to the money actually tied up in earning it, so it measures how efficiently the business uses its investment rather than just how large its profit is.

A firm's profit is rising but its ROCE is falling. What does that tell you?

The capital employed is growing faster than the profit it generates, so the extra investment is earning a poorer return than the money already in the business.

OCR A-Level Business (H436) H436

Business Activity

Topic overview Buying, selling and adding value Spotting an opportunity and starting a business Entrepreneurs and intrapreneurs Risk, reward and uncertainty Business objectives: profit, growth, survival and sustainability SMART objectives and the usefulness of objectives Primary, secondary and tertiary sectors Sole traders and partnerships Private and public limited companies Liability, legal status and choosing an ownership structure Social enterprises and not-for-profit organisations The stakeholders of a business What each stakeholder wants from a business Conflicting stakeholder objectives Measuring the size of a business Organic growth and franchising Mergers, takeovers, integration and diversification Factors influencing the scale of operations Economies and diseconomies of scale Market power and overtrading Stages of the customer journey Customer experience and how it is measured

Marketing

Topic overview The purpose of marketing and the unique selling point Market orientation and product orientation Why a business researches its market Primary research: questionnaires, focus groups and observation Secondary research sources and their reliability Random, stratified and systematic sampling Qualitative and quantitative research data Market size, market share and market growth Consumer markets and business markets Mass markets and niche markets Segmenting a market into customer groups New product development, innovation and R&D The product life cycle and extension strategies The Boston Matrix and product portfolio analysis Skimming, penetration and cost-plus pricing Competitor, psychological, dynamic and freemium pricing Price and income elasticity of demand Advertising, sponsorship and public relations Sales promotion, direct mail and point of sale Branding and packaging Social media, influencers and content marketing Websites, search engine optimisation and pay-per-click advertising Distribution channels, e-commerce and intermediaries Why businesses forecast their sales Historical sales forecasting and the line of best fit Intuitive forecasting and forecasting for a new product Big data and artificial intelligence in marketing Gamification, virtual reality and augmented reality Complaints, reviews and the net promoter score

People

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Operations

Topic overview The purpose of operations and the transformation process Added value and how it is calculated Ways of adding value: convenience, branding, design and facilities Sustainability as a way of adding value Automation, robotics and 3D printing in production AI, cloud services and digital technology in production Efficiency, effectiveness and productivity Measuring and improving productivity Production quality: purpose and standards Quality control and quality assurance Capacity utilisation and how it is calculated Managing capacity: increasing output, cutting capacity and outsourcing Types of inventory and the purpose of inventory control Inventory control charts, re-order levels and lead time Just In Time and inventory management systems The stages of supply chain management Logistics: procurement, transport and reliability of supply Key performance indicators in operations

Finance

Topic overview The finance function and business failure Assets, liabilities and capital Cash, profit and working capital Cost behaviour and sales revenue Contribution and the break-even point Break-even charts and the margin of safety Using contribution to make short-term decisions Levels of profit and profit margins Budgets and budget setting Budget variances Cash flow forecasting and its uses The structure of a cash flow forecast Remedies for a cash flow shortage Liquidity, the current ratio and the acid test Retained profit, owners' investment and asset sales Loans, overdrafts and other debt finance Share capital, venture capital, crowdfunding and grants Choosing a source of finance Financial statements and who uses them The income statement The statement of financial position (balance sheet)Return on capital employed and gearing Inventory turnover, receivable days and payable days Ratio analysis and its limitations

External Influences

Topic overview Demand, supply and the market mechanism Price, income and the drivers of demand Costs, capacity and the drivers of supply Rivalry, market share and competitor behaviour Imports, exports and the case for open trade Trade barriers and trade agreements Exchange rates and the value of the pound Culture, law and politics in overseas markets The forces behind a globalised market Political stability and the reach of government policy The business cycle and the state of the economy Interest rates, tax and subsidies Demographics, lifestyle and cultural change Shopping habits, communities and pressure groups Artificial intelligence, automation and robotics Cybersecurity, cloud services and connected devices

Strategy, Risk and Managing Change

Topic overview Business planning and the reduction of risk The uses and limitations of a business plan Business strategy and the interdependence of business decisions SWOT analysis PEST analysis The Ansoff matrix Porter's five forces Opportunity cost, risk and uncertainty in decision making The stages of making a business decision Corporate planning from objectives to evaluation Handy's four organisational cultures The payback period Average rate of return Net present value and discounted cash flow Judging an investment decision Contingency planning and disaster recovery Crisis management and the response to a crisis Insurance and the protection it gives a business Internal and external causes of change The effects of change on a business Barriers to change and resistance Lewin's force field analysis Critical path analysis and the critical path Total float, free float and the use of a network Monitoring change with quantitative and qualitative data Ethical treatment of workers and suppliers Ethical marketing and community engagement Consumer and employee protection law Pollution, waste and the environmental audit Sustainability, net zero and the circular economy ESG reporting

Finance

Return on capital employed and gearing

1 thing to know
Component 02

Overview

Recall questions on return on capital employed and capital employed, calculating and improving ROCE, the gearing ratio and how to calculate it, the dangers and deliberate use of high gearing, and ways to reduce it.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Numbers

State the formula for return on capital employed.

Questions from this subtopic

Each one with the model answer underneath.

1
State the formula for return on capital employed.
Model answer
ROCE = operating profit divided by capital employed × 100.
2
What is capital employed?
Model answer
It is the total long-term finance invested in the business, calculated as total equity plus non-current liabilities.
3
A firm has operating profit of £120,000, equity of £400,000 and non-current liabilities of £200,000. Calculate its ROCE.
Model answer
Capital employed is £600,000, so ROCE is £120,000 divided by £600,000 × 100 = 20%.
4
Why is ROCE compared with the return available on a bank deposit?
Model answer
The capital could have been left in the bank earning interest at no risk, so a business earning less than that is not rewarding its investors for the risk they are taking.
5
Why is ROCE regarded as the most important profitability ratio?
Model answer
It relates profit to the money actually tied up in earning it, so it measures how efficiently the business uses its investment rather than just how large its profit is.
6
A firm's profit is rising but its ROCE is falling. What does that tell you?
Model answer
The capital employed is growing faster than the profit it generates, so the extra investment is earning a poorer return than the money already in the business.

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