How to Measure Profitability of a Company?

By | March 18, 2012
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In order to measure profitability of a company the best tool is Return on Capital Employed (ROCE). Investors can also look into Profit & Loss accounts to check net profit (PAT) levels. But looking into absolute value of profits says nothing about the profitability level of a company.Investors have a common objective of buying stocks of good business. In financial terms, a good business is one that has shown consistently high Return on Capital Employed (ROCE). Return on capital employed is expressed as percentage (%) of total ‘tangible capital invested’ in business. In order to measure profitability of a company, ROCE is the best tool. There are several advantages of being aware of profitability of a company (more than just PAT). Investors can use profitability levels of one company and compare it with other. Lets take an example company A & B. The company with higher levels of profitability (ROCE) will be considered better for investment. But this is not the case with PAT. Let us see an example:

PAT Profitability (ROCE)
Company A $ 500,000 6%
Company B $ 250,000 12%

An investor must prefer Company B over A as B’s ROCE is better. But if one does not know the ROCE concept, then by just looking at PAT, he/she will be tempted to invest in Company A. The investing logic is simple, a company which has prospects of faster growth shall be preferred for investing. Return on capital employed (ROCE) calculation gives us just this idea. It shows us how profitable a company is and how fast it can grow its profits in times to come. But if ROCE is so effective way to measure profitability of a company then why lot of investors does not use it?

Measure Profitability of a Company using ROCE

The hard part with ROCE is that; where PAT figures are directly available on profit & loss accounts, return on capital employed (ROCE) needs to be manually calculated. In this article we will see how to measure profitability of company using ROCE. To buy shares of good business, it is very important to know the ROCE figures.

Return on Capital Employed (ROCE) = PBIT / Capital Employed

PBIT (Profit Before Interest & Tax)

PBIT can be back calculated from Net Profit (PAT) by adding to it the interest and depreciation. All three figures PAT, interest & depreciation can be easily obtained form the profit & loss accounts of company. In order to compare the profitability of two companies, it is better to use PBIT instead of PAT because PBIT brings companies in same platform. Different companies work in different geographical locations. Working in different locations imposes different interest rates and local tax structures.

PBIT =  Net Profit (PAT) + Interest + Tax

Capital Employed

Employed capital gives an idea about how well company is using its funds to run its business. Company generates its funds from shareholders equity and debt it takes from banks etc. Idea of measuring profitability of company using ROCE is to know how much profit a company can generate from its capital employed.


Capital Employed = Shareholders Equity + Debt

This invested capital creates profits (PAT). The objective of any company is to generate maximum profits with minimum capital investment. Lets take an example:

PAT Capital Employed Profitability (ROCE)
Company C $ 500,000 $ 8,333,333 6%
Company D $ 500,000 $ 4,166,666 12%

An investor would like invest in company D over C because it generates the same level of profits (PAT) from less capital employed. This shows that the company D is more profitability than company C.

List of Top 25 Most Profitable Companies in India

(Updated as on NOVEMBER’2013)

SL Company name  Market cap ROCE (5YR. AVERAGE) %
1 Colgate-Palmolive (India) Limited 169.90B 115.75
2 Castrol India Limited 147.68B 75.44
3 Nestle India Limited 546.20B 54.97
4 eClerx Services Limited 36.24B 47.28
5 Symphony Ltd 13.98B 46.69
6 Amrit Banaspati Company Ltd 1.08B 44.78
7 Bajaj Auto Ltd 588.18B 46.43
8 Balmer Lawrie Investments Ltd. 3.89B 46.74
9 Hawkins Cooker Ltd 11.11B 57.42
10 CRISIL Ltd. 75.93B 45.5
11 Zydus Wellness Ltd 22.08B 45.41
12 Bajaj Corp Limited 35.46B 44.38
13 Hero Motocorp Ltd 408.72B 44.48
14 Tata Consultancy Services Limited 3.97T 39.58
15 Bharat Agri Fert & Realty Ltd 378.44M 40.8
16 IL&FS Investment Managers Ltd. 3.94B 39.35
17 Cochin Minerals and Rutile Ltd 704.31M 33.48
18 Bayer CropScience Ltd 63.38B 39.46
19 Page Industries Limited 55.32B 37.46
20 Amrit Corporation Ltd 989.68M 35.55
21 Mayur Uniquoters Limited 6.76B 38.11
22 Piramal Enterprises Ltd 95.65B 33.92
23 RS Software India Ltd 1.84B 34.18
24 Dabur India Limited 285.72B 32.75
25 TTK Prestige Limited (Parent) 36.94B 38.93

Profitability of above companies have been analyzed based on Capital Employed, Asset and Equity holdings of company


Article Checked by Getmoneyrich

5 thoughts on “How to Measure Profitability of a Company?

  1. Rahul

    Is there any tool available that calculates the ROC automatically..like a calculator?
    Thanks

    Reply
  2. payday loans

    This is a topic which is near to my heart…
    Thank you! Exactly where are your contact details though?

    Reply
  3. Rehna Ghosh

    Sir.
    I am new to investing and have gone through the article which was very educative. To learn more on this I tried to calculate ROC and Earnings Yield of a sample company TCS. Although calculation of Earnings yield was simple, ROC was bit confusing. I was looking both Bal sheet and profit and Loss statement of TCS provided by moneycontrol site. The following are my doubts.
    1. Is PBIT and PBDIT the same.
    2. The is no figure for PAT, but Net profit is there. Is this the PAT.
    3. when calculating Fixed asset with the formula Gross Block – Current Asset, i found it was coming negative, since current asset was more than gross block.
    4. Where to get the working capital and fixed assets figures from.

    I would be grateful if you could mail me a sample calculation of any company with its connected financial statements, I could corelate the same and learn more.

    Thanks and Regards.
    Ms Rehna Ghosh

    Reply
  4. soumen kumar roy

    i am a follower of ur blog.Ur recent post (Posted: 30 Nov 2012 09:08 AM PST) grow my interest.Basically i am a mechanical engineer,invested in some of cases & every times book losses.so,i am searching the ways of making profits.Ur thinking & motivating writing astonished me very much.
    keep writing which inspires so many readers like me.
    I am trying to capture yr article,but fail to understand.so,if you kindly describe the magic formula for first 1 to 10 rank company in nse or bse by calculating. I would be grateful if you could mail me a sample calculation of any such companies.

    Thanking u.

    Reply

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