Today we'll look at Varun Beverages Limited (NSE:VBL) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

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

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

How Do You Calculate Return On Capital Employed?

Analysts use this formula to calculate return on capital employed:

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

Or for Varun Beverages:

0.16 = ₹9.4b ÷ (₹85b - ₹25b) (Based on the trailing twelve months to June 2019.)

So, Varun Beverages has an ROCE of 16%.

View our latest analysis for Varun Beverages

Does Varun Beverages Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Varun Beverages's ROCE appears to be around the 16% average of the Beverage industry. Separate from Varun Beverages's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Our data shows that Varun Beverages currently has an ROCE of 16%, compared to its ROCE of 12% 3 years ago. This makes us think the business might be improving. You can see in the image below how Varun Beverages's ROCE compares to its industry. Click to see more on past growth.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Varun Beverages.

Varun Beverages's Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.