Which efficiency ratio measures the profit of a business in relation to its size (capital employed) and indicates profitability of capital used?

Which efficiency ratio measures the profit of a business in relation to its size (capital employed) and indicates profitability of capital used?

• A. Return on Capital Employed (ROCE)
• B. Gross margin ratio
• C. Current ratio
• D. Asset turnover ratio

Answer: (A)

Profitability relative to the capital invested is what this ratio measures. Return on capital employed (ROCE) compares the profit a business earns from its operating activities to the amount of capital used to run the business. The idea is to see how effectively the firm uses its capital to generate earnings, so a higher ROCE indicates more efficient use of capital. Key points to understand: ROCE uses operating profit (earnings before interest and tax) as the numerator and capital employed as the denominator. Capital employed can be defined as total assets minus current liabilities, or equivalently as shareholders’ equity plus non-current liabilities. This makes ROCE a true measure of profitability in relation to the scale of the business’s long-term funding. By contrast, the gross margin ratio looks at profitability after production costs but before other expenses, and it is tied to sales price and cost of goods sold rather than how efficiently capital is used. The current ratio is about liquidity, not profitability, indicating whether short-term obligations can be met. The asset turnover ratio shows how efficiently assets generate sales, but it does not directly relate profit to the capital invested.

Profitability relative to the capital invested is what this ratio measures. Return on capital employed (ROCE) compares the profit a business earns from its operating activities to the amount of capital used to run the business. The idea is to see how effectively the firm uses its capital to generate earnings, so a higher ROCE indicates more efficient use of capital.

Key points to understand: ROCE uses operating profit (earnings before interest and tax) as the numerator and capital employed as the denominator. Capital employed can be defined as total assets minus current liabilities, or equivalently as shareholders’ equity plus non-current liabilities. This makes ROCE a true measure of profitability in relation to the scale of the business’s long-term funding.

By contrast, the gross margin ratio looks at profitability after production costs but before other expenses, and it is tied to sales price and cost of goods sold rather than how efficiently capital is used. The current ratio is about liquidity, not profitability, indicating whether short-term obligations can be met. The asset turnover ratio shows how efficiently assets generate sales, but it does not directly relate profit to the capital invested.