Translation: Return on Invested Capital (ROIC) = Return on Invested Capital

Return on Invested Capital (ROIC) is an indicator that measures how effectively a company can allocate and utilize its capital (whether financed by owners or debt) to generate operating profits. A high ROIC reflects management’s efficiency in creating value, but it should always be compared with the cost of financing to determine whether the company is actually creating or destroying value.

Simplified definition: It is a financial indicator that measures management’s ability to generate profits from the actual financing available to the company, regardless of the source of that financing (whether shareholders’ funds or bank loans and credit facilities). In other words, it shows you how many riyals of net operating profit the company can generate for every riyal invested in the business.

Calculation method:

The indicator is calculated by dividing net operating profit after tax by total invested capital and multiplying the result by 100.

Note: Invested capital represents the funds actually allocated to operating activities, including equity, debt, and financing facilities, minus unused cash.

Example: Suppose a company operating in the retail and manufacturing sectors has shareholders’ equity of SAR 300 million and has obtained bank credit facilities and loans worth SAR 200 million, making total "invested capital" SAR 500 million. At the end of the year, the company generated "net operating profit after tax" of SAR 60 million.

This means that the return on invested capital is 12%.

Result: The company generated 12 halalas in net operating profit for every riyal invested in its operating capital.

= (Net operating profit after tax / Invested capital) * 100

What does this mean for you?

  • High level (above the cost of financing, WACC): This is the true indicator of management’s success in identifying opportunities and allocating capital highly efficiently (as in acquisitions and expansion), generating a return higher than the cost of obtaining funds and thereby creating sustainable added value for shareholders.
  • Declining or low level: This indicates that the company is injecting funds and loans into projects or acquisitions that do not generate sufficient returns to cover financing costs, meaning that new investments consume liquidity without generating a worthwhile return.
  • Fair comparison between companies: ROIC is considered the gold standard for investors because it eliminates the impact of financing preferences; it compares companies based on their efficiency in generating operating profit, whether they rely on debt or equity.

Frequently asked question: Why do investors prefer to measure ROIC and compare it with the "weighted average cost of capital (WACC)" rather than relying solely on the ordinary profitability indicator?

Answer: Because achieving a return on investment does not necessarily mean that the transaction is successful! If the company’s ROIC is 7% while the cost of financing its funds and debt (WACC) is 9%, the company is actually "destroying value" and losing money over the long term despite reporting numerical profits. True financial success is achieved only when ROIC is greater than WACC.