It measures profitability after factoring in the amount of capital used in a business or a project at a period of time. As a true measurement of value creation, the ratio shows how much profit each pound of employed capital generates. This metric also measures value created for a firms’ shareholders as it illustrates the effectiveness of long-term financing strategy and how efficient the business can use its capital (Damodaran, 2007). A notable aspect of accounting based measures is that they are able to compare firms within an industry and evaluate how profitable the entity is relative to its size. However, Damodaran argues that this metric tends to favour mature companies as their assets have depreciated over a long period, thus manipulating the level of capital employed. Evans (2014) corroborates this point by using Tesco as an example where more capital is being occupied, but there is insufficient returns, which has led to a decrease in their
It measures profitability after factoring in the amount of capital used in a business or a project at a period of time. As a true measurement of value creation, the ratio shows how much profit each pound of employed capital generates. This metric also measures value created for a firms’ shareholders as it illustrates the effectiveness of long-term financing strategy and how efficient the business can use its capital (Damodaran, 2007). A notable aspect of accounting based measures is that they are able to compare firms within an industry and evaluate how profitable the entity is relative to its size. However, Damodaran argues that this metric tends to favour mature companies as their assets have depreciated over a long period, thus manipulating the level of capital employed. Evans (2014) corroborates this point by using Tesco as an example where more capital is being occupied, but there is insufficient returns, which has led to a decrease in their