The Key to the ROIC Formula, Unlocked

Arjun Ruparelia

Last updated on Jun 10, 2025

QUICK SUMMARY

ROIC tells you how profitable your business is. But how exactly do you calculate it? Learn what it is, how to find it, and how to increase your output in my detailed guide.

Key Takeaways

What Is ROIC?: Return on invested capital (ROIC) is used to determine how profitable your business is. To find it, you need to calculate your NOPAT and invested capital amounts.

The Limit Does Exist: There are limits to the ROIC formula, including the fact that it changes depending on the analyst, it ignores growth potential, and it's prone to distortion.

Increasing Your Value: You can build a better ROIC output by increasing your NOPAT or decreasing your invested capital. Both have benefits that can directly impact your final output.

ROIC is a metric that CFOs and investors watch closely, and for good reason. If it’s higher than a company’s cost of capital, value is being created. If not, there may be trouble ahead: wasted interest costs, weaker shareholder equity, or limited room to raise future funds.

Back when I was working as an accountant, I spent a lot of time digging into financials and advising on capital allocation. Over time, I came to see ROIC as a kind of shortcut to understanding a business’s true performance, beyond what’s on the income statement.

But it isn't always so easy to understand. That's why I put together this guide. In it, I’ll walk you through what ROIC is, why the formula isn’t always one-size-fits-all, and how companies can improve it. Whether you’re prepping for an interview or just want to get sharper at analysis, this guide is a great place to start.

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What Is Return on Invested Capital?

Return on invested capital (ROIC) is a profitability ratio that tells you how effectively your company uses capital to generate income/cash flow. Most often then not, ROIC consists of two components: debt and equity. And there’s a cost to both types of capital.

For example, suppose you pay 5% per annum interest on debt, and your equity investors expect to generate 8% on their capital. Half of your capital is debt, and the other half is equity. This translates to a 6.5% weighted average cost of capital (WACC) calculated as follows:

WACC = [(5% x 0.5) + (8% x 0.5)]

If your WACC is 6.5%, ROIC above 6.5% shows you’re creating value. On the other hand, a lower ROIC shows you’re destroying value.

The Formula of Relativity:

It’s important to remember that ROIC is a relative metric. A 15% ROIC can be excellent while a 30% ROIC can be terrible, depending on your cost of capital.

How To Use the ROIC Formula

Now, I explained what ROIC is, using the formula in my example. But that leaves the question: what exactly is the formula I used and how did I arrive at that final number of 6.5%?

Let’s break it down. When calculating ROIC, you will typically use the following formula:

ROIC = Net Operating Profit After Taxes (NOPAT) / Invested Capital

The formula is arithmetically simple, but the figures required to calculate ROIC (NOPAT and invested capital) require some additional calculations. Here’s how you can calculate the ROIC for your business using the above formula.

1. Calculate NOPAT

Let’s start with the numerator. Our first goal is to calculate NOPAT—the amount of income your business generated from core operations after tax, assuming there was no debt.

There are two approaches to calculating this figure. The first one is the most simple, and is as follows:

NOPAT = Operating Income x (1 - Tax Rate)

To put this formula in perspective, you’re essentially just subtracting your tax liability from the operating income. The interest expense isn’t subtracted here since we’re working under the assumption that the company has no debt.

There’s another way to calculate NOPAT as well, albeit it’s a little more extensive:

NOPAT = [Net Income + Tax + Interest Expense + Non-Operating Losses - Non-Operating Gains] x (1 - Tax Rate)

Both NOPAT formulas should yield the same valuation if your calculations are correct. Take the following table for example. Suppose this is company A’s income statement for the last year:

Particulars	Amount ($)
Revenue	10,000
Less: Cost of Goods Sold (COGS)	(3,000)
Gross Profit	7,000
Less: SG&A	(2,000)
Operating Income (EBIT)	5,000
Less: Interest Expense	(2,000)
Profit Before Tax	3,000
Less: Tax (30%)	(900)
Net Income	2,100

In this case, the NOPAT is $3,500, calculated as follows using the first formula with the 30% tax rate:

3,500 = 5,000 x (1 - 30%)

If you were to use the second, longer formula, here’s what the calculations would look like, also arriving at the same outcome:

3,500 = (2,100 + 900 + 2,000) x (1 - 30%)

2. Calculate Invested Capital

Next, you’re going to want to determine your invested capital. The denominator, invested capital, is the total capital deployed into your business model to generate operating profits from both equity and debt, excluding non-operating assets.

There are two ways to calculate invested capital. The first method (the operating approach) is for a clean computation:

Invested Capital = Net Working Capital + Net PP&E + Other Operating Assets - Other Operating Liabilities

Below is a further look at what each of these factors entail:

Net Working Capital: (Current Assets - Cash) - (Current Liabilities - Debt)
Net PP&E: Property, Plant & Equipment, Net of Depreciation
Other Operating Assets: Assets other than PP&E, excluding non-operating assets like excess cash, marketable securities, and goodwill.

The second method (the financing approach) is easier when using public filings to calculate ROIC since it eliminates the need to dig into notes to accounts. Here’s the formula:

Invested Capital = Total Debt + Total Equity - Non-Operating Assets

And a deeper dive into what each of these factors entail:

Total Debt: Short-Term + Long-Term Debt
Total Equity: Common Equity + Preferred Equity
Non-Operating Assets: Excess Cash and Other Non-Operating Assets

Say after analyzing company A’s balance sheet, you’ve pulled the following information:

Particulars	Amount ($)
Net Working Capital	20,000
Net PP&E	25,000
Other Operating Assets	10,000
Other Operating Liabilities	5,000

Using the formula for invested capital, company A will see an invested capital of $50,000:

$50,000 = $20,000 + $25,000 + $10,000 - $5,000

3. Divide NOPAT by Invested Capital

The last, and final step, is simple: divide NOPAT by invested capital to calculate ROIC.

Continuing with company A, after finishing the calculation, their ROIC would be 7%, calculated as follows using the ROIC formula:

7% = $3,500 / $50,000

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Example ROIC Formula Calculation

While it may seem like a relatively easy calculation, as anyone in the industry knows, things in finance are rarely as simple as explained above.

Until now, we’ve talked about canonical ROIC formulas from the textbook, but analysts typically tweak formulas to add company-specific context when calculating ROIC.

Let’s use Walmart as an example for ROIC calculation to showcase how ROIC looks for larger enterprises. If you look at Walmart’s latest 10K (available on its website), here are the figures you’ll find:

Operating Income (EBIT): $29.348 billion
Effective Tax Rate: 21% (income tax expense of $6.152 billion on a pre-tax income of $29.348 billion)

Based on this information, here’s a calculation of Walmart’s NOPAT of $20.73 billion:

$23.19 billion=$29.348 x (1 - 0.21)

Here are some more figures from Walmart’s balance sheet that we’ll need to know going forward with the formula:

Particulars	Amount ($B)
Total Assets	260.823
Cash and Cash Equivalents	9.037
Goodwill	28.792
Indefinite-Lived Intangible Assets	4.5
Equity Investments (Level 1 & 2 fair value)	3.041

After finding NOPAT, the next step is to calculate the invested capital. But for that, we first need to calculate the total operating assets. We have the total assets figure, so let’s calculate the total non-operating assets using the following formula:

Non-Operating Assets = Cash and Cash Equivalents + Goodwill + Indefinite-Lived Intangible Assets

For Walmart, this number will be as follows:

$45.37 billion = 9.037 billion +28.792 billion +4.5 billion +3.041 billion

From there, you can find the company’s operating assets by subtracting the non-operating assets from the total assets to get the following amount of $215.45 billion:

Operating Assets = $215.45 billion= $260.823 billion - $45.37 billion

Walmart also has non-interest-bearing current liabilities of $88.01 billion, of which $58.666 billion are accounts payable and $29.345 billion are accrued liabilities.

Now, we have all the information needed to calculate ROIC, but this time, we'll take a different approach instead of using the canonical formula.

When calculating the ROIC ratio, we’re essentially trying to compute the deployed capital that requires a return. Accounts payable, for example, don't add interest expense to your income statement. We can’t use the capital made available to the company by creditors, which is temporary, when trying to assess the ability of the capital to generate a return more than the cost of capital.

Using the information available to us, we can now calculate the invested capital using a slightly different formula:

Invested Capital = Operating Assets - Non-Interest Bearing Liabilities

In Walmart's case, here's what the final output will be:

127.44 billion = $215.45 billion - 88.01 billion

If you isolate all components on the balance sheet and perform accurate, detailed computations, both approaches (the textbook formula and the one we used here) will yield the same answer.

Using the NOPAT and invested capital figures, we can calculate Walmart’s ROIC:

18.2% = $23.19 billion / $127.44 billion

If you look at Walmart’s ROIC in other publications or websites, you might see a different ROIC figure on each. That’s because analysts often make adjustments to NOPAT and invested capital computations.

Some analysts use the average of invested capital over time. Similarly, some don’t subtract goodwill when calculating invested capital if they want the ROIC to reflect the cost of acquisitions—these analysts are trying to look at ROIC as a capital stewardship measure and not just operational efficiency.

When To Use the ROIC Formula

The best time to calculate ROIC depends on why you’re calculating it, but in most cases, ROIC is determined after a full fiscal year. This is because:

Annual financial statements are audited and complete
Operating income and capital balances are fully updated
Seasonality and one-time charges are smoothed out

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Everything ROIC Can Tell You

ROIC tells you how efficiently your company turns capital into post-tax operating income. It’s essentially a capital efficiency metric that tells you your company’s profitability and whether you’re making good use of invested capital.

There’s no one figure you can define as a threshold for good ROIC. However, you can look at peer companies or industry averages if you’re looking for a benchmark. For starters, your ROIC should be greater than your WACC. If ROIC is lower than WACC, you’re destroying shareholder value.

Limits of the ROIC Formula

While the ROIC formula is valuable, there are some limitations. Here are a few I’ve noticed throughout my career:

Many Different Versions: Some analysts include goodwill, others don’t. Some subtract all cash, others only the excess. Some average invested capital, others use the year-end. This lack of consistency makes cross-company comparison tricky.
Ignores Growth Potential: ROIC tells you how effectively you’re using invested capital now, but it doesn’t tell you how much you can reinvest while still generating the same ROIC. A high-ROIC business with no future growth opportunities can be less valuable than a moderate-ROIC business with massive reinvestment potential, so be sure to factor in this limitation.
Prone To Distortions: Unusual gains or losses from asset sales, litigation, or restructuring can skew EBIT. This means your NOPAT figure could look disproportionately large or small in a particular year unless you adjust the formula to exclude the unusual gain or loss.

Top Tips to Increase ROIC Formula Output

There are essentially two ways to achieve a higher ROIC: increasing NOPAT or decreasing invested capital. Here's a closer look at how to achieve each:

Most businesses can increase their ROIC by increasing their NOPAT or decreasing the amounts put into invested capital.

Increase NOPAT

Increasing NOPAT requires increasing profit margins—something every business makes constant effort towards. The specific strategies to improve profitability depend on your industry, but here are some generic examples:

Optimize Product Mix To Increase Margins: Analyze gross margin contribution by SKU to identify low-margin products or products that consume high working capital or SG&A. See if you can kill or divest low-margin, capital-intensive products.
Try Cutting Costs: Start with a zero-based budget, identify expense line items on the income statement that have grown faster than revenue in the recent past, and see if there’s room for lowering those costs.
Automate Processes: Automating processes using software is also an excellent way to cut costs. For example, using financial software can help you track ROIC as well as automate processes and free up your finance team’s time to focus on more strategic tasks.
Favorable Tax Structuring: See if you’re eligible for a tax credit. For example, companies in some industries can claim tax credits for R&D spending, and companies in hiring zones can also get tax credits for creating jobs. You can also use various transfer pricing and IP location strategies in multinational structures.

Decrease Invested Capital

Companies typically have greater control over capital structure than profitability. Of course, there’s no single appropriate strategy to reduce invested capital for every business. But here are some general strategies:

Divest or Monetize Low-Yield Assets: Look at your company’s assets to find underperformers—ones with a low return on capital—and sell them. For example, a manufacturing plant might consider spinning off a plant used to manufacture a component in-house and outsourcing production.
Convert CAPEX To OPEX: Similar to the previous strategy, this strategy goes a step further than just low-yield assets. Instead of investing in capital-intensive assets, outsource non-core assets like real estate, logistics, and IT infrastructure. Switch to cloud, SaaS, and platform services instead of in-house builds.

Tips for Cutting

Asset-light strategies can reduce your operating income, so weigh the pros and cons before using this strategy. For example, if you don’t buy real estate, you’ll have a rent expense on the income statement, which will lower your income.

Think of ROIC Before Investing: Set a minimum ROIC threshold for any internal investment decisions or M&A and tier projects by ROIC and payback period instead of net present value (NPV). Calculate ROIC before funding to avoid tying up capital in low-return capital in the first place.

ROIC vs. ROCE

ROIC measures how efficiently a company generates after-tax operating profit from the capital it controls (debt and equity). On the other hand, ROCE (return on capital employed) measures how much net income a company generates relative to only the return on equity capital. Here’s the formula:

Here’s a quick overview of the differences between the two metrics:

ROIC measures operating efficiency, while ROCE measure the return generated for equity holders.

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ROIC is a Value Creation Metric

ROIC is essentially a metric to measure value creation.

It’s true that ROIC measures the efficiency with which your operating assets generate income. However, implicit in that statement is the idea that your operating assets need to generate more income than what the capital for those fixed assets costs to create shareholder value.

For example, if you borrow money at 5% and buy an asset, it needs to generate more than 5% to create value for you.

Of course, you can always view value creation through different lenses. For example, CFOs look at ROIC to make capital allocation decisions, while investors use it to assess business quality.

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