What is the Return on Capital (ROC)

The return on capital (a.k.a. return on invested capital) formula takes a stab at correcting for the debt anomaly by adding long-term debt to the equity figure in the ROE equation.

return on capital = net income/(shareholders’ equity + longterm debt)

The ROC formula makes a big difference, but it doesn’t completely solve the problem. ROC works when firms follow the intent, rather than the letter, of accounting rules:

1. They confine items listed as short-term liabilities to accounts payable, income taxes payable, and so forth.

2. They list all of their long-term debts on the balance sheet line labeled “long-term debt.”

That doesn’t always happen. Some firms have replaced longterm debt with continuously renewed short-term instruments, and list them on the balance sheet as short-term debt. Some list long-term obligations as other long-term liabilities instead of as long-term debt.

Bottom line: debt is debt, wherever it’s listed. Baring outright fraud, all debt will be listed as a liability somewhere on the balance sheet. It’s easier to count everything instead of trying to outguess the company’s accountants.