Today we'll look at D4t4 Solutions Plc (LON:D4T4) and reflect on its potential as an investment. 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.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

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

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. Ultimately, it is a useful but imperfect metric. 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'.

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 D4t4 Solutions:

0.13 = UK£3.3m ÷ (UK£30m - UK£3.9m) (Based on the trailing twelve months to September 2019.)

Therefore, D4t4 Solutions has an ROCE of 13%.

See our latest analysis for D4t4 Solutions

Does D4t4 Solutions Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see D4t4 Solutions's ROCE is around the 12% average reported by the IT industry. Independently of how D4t4 Solutions compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

D4t4 Solutions's current ROCE of 13% is lower than its ROCE in the past, which was 22%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how D4t4 Solutions's past growth compares to other companies.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. You can check if D4t4 Solutions has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect D4t4 Solutions's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

D4t4 Solutions has current liabilities of UK£3.9m and total assets of UK£30m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On D4t4 Solutions's ROCE

This is good to see, and with a sound ROCE, D4t4 Solutions could be worth a closer look. There might be better investments than D4t4 Solutions out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.