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Navigating Uncertainties in Ratio Analysis: A Focus on Return on Capital Employed

This analysis delves into the complexities surrounding financial ratios, particularly Return on Capital Employed (ROCE). With various definitions and interpretations, analysts must grapple with ambiguities in financial statements and disclosures. Key considerations include the definition of profit as PBIT and the inclusion of different forms of capital, such as equity, debt, and liabilities. Additionally, the treatment of current liabilities and the distinction between tangible and intangible assets raises further questions. Ultimately, this piece emphasizes the importance of analyst discretion in defining and using financial ratios.

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Navigating Uncertainties in Ratio Analysis: A Focus on Return on Capital Employed

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  1. Analysis uncertainties There are many ‘definitions’ for ratios Items shown in financial statements may be vague and full disclosure may not be available Financial standards hope to encourage useful disclosure Every analyst should decide for themselves how to define a ratio and what to include

  2. Analysis uncertainties ROCE Return On Capital Employed which profit PROFIT CAPITAL which capital

  3. Analysis uncertainties ROCE ‘standard’ definition PROFIT = PBIT CAPITAL = EQUITY + DEBT which debt?

  4. Analysis uncertainties ROCE ‘standard’ definition PROFIT = PBIT CAPITAL = EQUITY + LIABILITIES which liabilities?

  5. Analysis uncertainties ROCE ‘standard’ definition PROFIT = PBIT CAPITAL= EQUITY + NON-CURRENT LIABILITIES

  6. Analysis uncertainties But should CURRENT LIABILITIES be included? PBIT equity + non-current + current liabilities liabilities

  7. Analysis uncertainties ROCE Return On Capital Employed is also PROFIT on ASSETS employed PROFIT ASSETS (net) which assets?

  8. Analysis uncertainties ROCE ‘standard’ definition PROFIT = PBIT ASSETS= non-current + current - current assets assets liabilities but what if the ‘current’ liabilities have the character of borrowings? should they be excluded?

  9. Analysis uncertainties PROFIT = PBIT ASSETS= non-current + current - current assets assets liabilities which non-current assets? should be all TANGIBLE + INTANGIBLE is intangible asset disclosure adequate in the financial statements?

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