Return on Invested Capital

Return on Invested Capital measures a companies net operating profit as a percentage of the leverage that they are using.  Leverage, or total invested capital in the formula below, in this context can be defined as:  Assets - Cash & Cash Equivalents (Cash, Accounts Receivable, Short term investments) - Long Term Investments - Current Liabilities.  These data points can be found on the balance sheet.

Net Operating profit has been slightly modified to adjust for tax.  You can calculate NOPAT, or net operating profits after tax, with the following formula:  Net Profit After Tax + After Tax Interest Expense - After Tax Interest Expense.  All the data points can be found on the income statement.

Return on Invested Capital (ROIC) Formula

This ratio is very similar to the return on equity calculation; however, it includes long term debt as part of the leverage.  It is considered by many to be a more accurate representation of profitability.  It is a great tool to use when comparing companies within the same industry, especially in capital intensive industries such as oil and telecommunications. 

ROIC will also give investors a good idea of how well management is putting their borrowed funds to work.  If ROIC is greater than WACC, or the weighted average cost of capital, the company is said to be increasing shareholder value.  The greater the spread between the two numbers, the better position the company is in to create wealth and add value. 
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