52 Weeks of FOS

Return on Invested Capital – Week #21 of The Financial Operating System®

Return on Invested Capital explained
June 23, 2025 by Calvin Wilder in Articles

In previous weeks we have focused mostly on income statement profit margin metrics. This week we focus on a different kind of metric: Return on Invested Capital (ROIC). This is a key metric for assessing how effectively a business is generating profit from the cash investment in the business. It measures the return on all capital—whether from equity or debt—used in the business. It’s important to know how much return investors are getting from investing in the business.

Key Concepts:

  1. Understanding ROIC:

    • Formula: ROIC = (Operating Profit × (1 – Tax Rate)) ÷ (Debt + Owner Equity). To simplify the math for pass-through entities that do not have company-level income tax, we can also use pre-tax profit.
    • ROIC provides a percentage reflecting how much profit is generated from each dollar of capital invested in the business.

  2. Capital Structure and ROIC:

    • A business’s capital structure—whether debt-free, highly leveraged, or balanced—significantly influences ROIC. Companies with different capital structures but similar income statements can have vastly different ROIC values.
    • For example, a company with no debt may have a higher ROIC than one with significant debt, despite similar operating profits.

  3. Healthy ROIC Targets:

    • Businesses should aim for a minimum of 30% ROIC after tax, which is considered healthy for well-capitalized businesses with strong profit margins.
    • A minimum pretax ROIC benchmark of 50% is the equivalent, with a target of 75%+ pretax for higher-performing businesses.

  4. Risk and ROIC:

    • ROIC can be misleading if a business is undercapitalized. A business with a low cash balance or high debt may report high ROIC but with elevated risk. A downturn may put it out of business. On the other hand, businesses with excess capital may report lower ROIC, but this does not necessarily mean they are underperforming, just that they have extra capital they can distribute to owners.
    • Owners must balance their desire for a high ROIC with the risk they are willing to take.

  5. Practical Application:

    • Businesses can improve ROIC by increasing operating profit or reducing the amount of capital required to generate those profits. Effective management of receivables, payables, and fixed assets can significantly influence ROIC.
    • The example provided in the book compares three companies with different capital structures but similar operating profits, illustrating how capital efficiency impacts ROIC.
    • This topic is math-heavy and best illustrated with examples. Download Chapter 7 of The Financial Operating System from at smartbooks.com/resources for examples of ROIC in different scenarios. 

  6. ROIC in Small Businesses:

    • Small businesses can achieve higher ROICs compared to larger public companies. While the most capital-efficient public companies can report ROICs of 15-20%, small businesses may achieve much higher returns, particularly in niche markets with low capital requirements, and need much higher ROIC in order to weather the risks and reduced access to capital borne by small businesses.

Conclusion:

ROIC is essential for evaluating the profitability of a business along with its income statement profit margins. A high ROIC indicates that a business is efficiently using its capital, which is crucial for long-term growth and profitability​.

Next Step:

Business owners can self-implement The Financial Operating System. Chapters are available to download at smartbooks.com/resources or you can buy the whole book from Amazon (the marketing firm version or the general business version).

If you would like assistance with implementation or would like to accelerate results for your business, please contact author Cal Wilder at cwilder@smartbooks.com or book a free consultation with our team directly using this calendar link.