Plain definition
Return on invested capital (ROIC) divides net operating profit after tax (NOPAT) by average capital invested in operations. NOPAT removes financing effects so the operating return can be assessed before deciding how the business is funded.
One approach defines invested capital as operating assets less operating liabilities. Excess cash is excluded; working capital used in the business is included. The treatment of leases, goodwill, and other adjustments must match the profit measure.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
A business has NOPAT of and average invested capital of . ROIC is 20%. An expansion raises average invested capital to but NOPAT reaches only . Total operating profit has grown, while ROIC has fallen to 18%.
The extra of NOPAT relative to of additional average capital suggests an incremental accounting return of 12%. That prompts a closer review of the expansion’s maturity and cash forecast rather than a conclusion based on the group’s 18% alone.
Why it matters
Growth can increase profit while reducing the efficiency of capital use. Comparing ROIC with a consistently defined after-tax cost of capital helps assess this, but a single period’s accounting ratio does not establish the value of an entire project.
Practical consequence
Reconcile NOPAT and operating capital to the accounts. Apply the same treatment of tax, cash, leases, and goodwill across periods. Separate mature operations from investments still ramping up, and use discounted project cash flows to test the value of new spending.