Today we'll evaluate Innovana Thinklabs Limited (NSE:INNOVANA) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Innovana Thinklabs:

0.58 = ₹106m ÷ (₹305m - ₹122m) (Based on the trailing twelve months to March 2018.)

Therefore, Innovana Thinklabs has an ROCE of 58%.

View our latest analysis for Innovana Thinklabs

Is Innovana Thinklabs's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Innovana Thinklabs's ROCE is meaningfully better than the 11% average in the Software industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Innovana Thinklabs's ROCE in absolute terms currently looks quite high.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. If Innovana Thinklabs is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Innovana Thinklabs's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.