Credit & Capital

Metric of the Month: Return On Invested Capital

It’s time to rethink those investments that won't earn high returns on capital in a post-COVID business landscape.
Perry D. Wiggins, CPAMarch 2, 2022
Metric of the Month: Return On Invested Capital
Photo: marchmeena29 via Getty Images

As countries begin to lift their pandemic restrictions and business leaders look toward post-COVID-19 business models, it’s important to ask whether the investments you made in 2020 (or earlier) still make sense. Reevaluating these investments can free up cash and enable investment in areas that drive long-term value. 

  Perry D. Wiggins

Return on invested capital (ROIC) brings clarity to these conversations. ROIC measures the amount of gain made on invested capital relative to the cost of investment. The metric lets an organization track how well it uses its money to generate returns. ROIC can be calculated by dividing an organization’s net operating profit after tax by the amount of invested capital dollars. It should be expressed as a percentage.

APQC finds that top performers on this measure (those in the 75th percentile) see a return of 12.8% or higher on invested capital. That’s nearly twice the return as that of bottom performers (those in the 25th percentile), who see a 7% return on their invested capital.

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These figures represent a cross-industry view of APQC’s benchmarking data for ROIC. It is important to benchmark this measure within your industry because ROIC can vary widely by industry. Health care organizations such as hospitals have much lower profit margins and may not see as much of a return from invested capital relative to a software company. Regardless of industry, a higher percentage is always better for this metric.

Boosting ROIC

The primary way to improve ROIC is to ensure that investments are aligned with the organization’s strategy. While this alignment should occur at least annually during strategic planning, many organizations need to revisit these conversations more frequently to account for a shifting COVID-19 landscape.

For example, now is a good time to rethink real estate footprints. If you have investments tied up in real estate but are moving toward a hybrid workforce model, you may be able to trim those investments.

Performing well on ROIC means investing more efficiently. In some cases, that might mean spending more money upfront for newer software or equipment, rather than continuing to maintain older equipment rapidly growing obsolete. 

Investing more efficiently also means trimming some investments. Plan thoroughly, thoughtfully, and collaboratively with your team to understand which investments you truly need to generate a return, because every investment has a point of diminishing returns. If your $10 million expansion can be an $8 million expansion and still achieve the same returns, you’ve just freed up money you can invest elsewhere.  

Once you’ve made investments, isolating the returns from them can be difficult. Some investments do not bring returns or do not bring them right away. Investments into fixed assets such as new equipment eventually generate cost savings because these investments help prevent machine downtimes and other problems. Customers won’t necessarily choose you over your competitor because you just installed new self-checkout kiosks. But they might choose your competitor over you if your self-checkout kiosks are broken and customers have to wait in long lines. Those investments are just as important as the ones that generate more visible returns.

An emergent post-pandemic business environment may require new investments or cutting older investments that don’t make sense anymore. Revisit your investments with your team to ensure that invested capital aligns with the business strategy in 2022 and beyond.

Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas.