Today we'll look at Visaka Industries Limited (NSE:VISAKAIND) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

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 Visaka Industries:

0.17 = ₹1.0b ÷ (₹9.3b - ₹3.3b) (Based on the trailing twelve months to June 2019.)

Therefore, Visaka Industries has an ROCE of 17%.

See our latest analysis for Visaka Industries

Does Visaka Industries Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Visaka Industries's ROCE appears to be substantially greater than the 10% average in the Basic Materials 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. Regardless of where Visaka Industries sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can click on the image below to see (in greater detail) how Visaka Industries's past growth compares to other companies.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. 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 Visaka Industries.

Do Visaka Industries's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Visaka Industries has total assets of ₹9.3b and current liabilities of ₹3.3b. As a result, its current liabilities are equal to approximately 35% of its total assets. Visaka Industries has a medium level of current liabilities, which would boost the ROCE.

The Bottom Line On Visaka Industries's ROCE

Visaka Industries's ROCE does look good, but the level of current liabilities also contribute to that. Visaka Industries shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.