“Why use ROIC?” — The reason it’s not ROA or ROE

Whenever I talk about ROIC, this question comes up almost every time. When I had the opportunity to explain it internally, the same point was raised.

The stumbling block is usually the concept of the denominator (invested capital).

The most time spent in budgeting is on sales and operating profit, and perhaps that is because the balance sheet (BS) is not as focused on in the budget as the profit and loss statement (PL) is.

What ROIC wants to see is how much profit was made by investing the capital raised into the business. From this perspective, the denominator for ROA is too broad, and for ROE it is too narrow. Let’s start by looking at that.

1. Response to “Isn’t ROA fine?” — The denominator is too broad

First, let’s line up the formulas.

• ROIC = NOPAT (Net Operating Profit After Tax) ÷ Invested Capital

• ROA = Profit ÷ Total Assets

The way the numerator is taken also differs by indicator (ROIC generally uses net operating profit after tax, while ROA uses net income), but what causes confusion in internal explanations is always the denominator. I will focus on this.

The denominator for ROA is total assets, which is everything the company owns. The denominator for ROIC is narrowed down from there in two stages.

Stage 1: Include only assets used for business

Cash and deposits with no determined use, or investment securities. These are assets unrelated to the business. Even though the numerator is the profit generated by the business, it is unbalanced if these are mixed into the denominator. Therefore, we exclude them.

ROA does not distinguish this, so assets not invested in the business remain in the denominator.

Stage 2: Include only the portion you provided yourself

Among the remaining business assets, there is the portion that suppliers have covered for you. These are unpaid purchase invoices, or accounts payable. This is not money you provided yourself.

Therefore, we subtract this as well. Subtracting accounts payable from accounts receivable and inventory—the calculation of working capital is this subtraction.

What remains is the invested capital.

Note that this “money you provided yourself” can also be counted from the procurement side rather than the asset side: Interest-bearing debt + Equity - Non-operating assets such as surplus cash and deposits. Since we subtract the cash on hand that has not yet been invested in the business, it matches the amount accumulated from the asset side.

(Incidentally, while inflating trade payables will shrink the denominator, this should be considered separately from the issue of manufacturing numbers by squeezing business partners.)

2. A response to "Isn't ROE fine?" — The denominator is too narrow

• ROE = Net Income / Shareholders' Equity

Now, conversely, the denominator is too narrow. This is because money borrowed from banks is not included. Borrowing is, after all, capital that has been raised.

There is also another side effect. If you increase borrowing and buy back your own shares, shareholders' equity decreases. Even though the substance of the business has not changed at all, ROE rises because the denominator becomes smaller. There is an aspect where it can move based on financial manipulation alone.

It is a meaningful indicator as a return from the perspective of shareholders. However, I think it is a bit too narrow as a yardstick for measuring the efficiency of capital invested in a business.

The denominator of ROIC includes both interest-bearing debt and shareholders' equity.

3. Why ROIC? — There is a passing line called WACC

I have been talking about the denominator so far, but I believe that the reason for using ROIC boils down to just one thing.

You cannot judge whether a figure of "ROIC 8%" is good or bad just by itself, but ROIC has a counterpart to compare against. WACC (Weighted Average Cost of Capital) — this is the rate of cost incurred on the capital, which is the average of the costs of interest-bearing debt and shareholders' equity based on the ratio of the amounts raised.

This is where the denominator point I mentioned earlier comes into play. Both the denominator of ROIC and the funds targeted by WACC were the same "interest-bearing debt + shareholders' equity." Since the playing field is leveled, the rates can be compared directly.

• ROIC 8% > WACC 6% → Earning more than the cost of capital

• ROIC 4% < WACC 6% → Even if profitable, value is being eroded

The important thing is the latter. Profits are being made. It is not in the red. Even so, the more you grow the business, the more value is lost. This is because you are only generating a 4% annual return on money raised at a 6% annual cost.

The true nature of the feeling that "I'm making a profit, but for some reason, I'm not being evaluated" usually lies here, doesn't it?

The "Growth Investment Guidance" formulated by the Ministry of Economy, Trade and Industry in July 2026 also defines value creation as "continuously generating returns that exceed the cost of capital" (Source). Whether it exceeds it or not is the dividing line.

What I don't want to overlook is the phrase "continuously".

Even if you exceed it in a single year, it is meaningless if you fall below it in the next period. Moreover, the line that must be exceeded moves itself. If interest rates rise, WACC also rises. Even if nothing changes on the business side, the passing line just keeps rising.

In the era of low interest rates that lasted for a long time, this line was always at a very low position. Even if efficiency was somewhat poor, it was difficult to notice that you were sinking below the line. Returning to an era with interest rates means that the line is rising.

Neither ROA nor ROE has this line.

There is no standard to judge whether an ROA of 5% is good or bad. Because the denominator, total assets, includes non-interest-bearing accounts payable, it is not on the same playing field as WACC. ROE can be compared to the cost of equity, but since it can be moved simply by increasing borrowing, it does not serve as an axis for evaluating business operations.

Come to think of it, there is no line for sales or profit that says "this amount is passing." There are only internal standards decided by the company, such as year-on-year or budget-versus-actual comparisons.

I believe ROIC is the only indicator that has a passing line given from the outside.Whether or not you are exceeding the level demanded by the providers of capital. You can answer that directly. This is the crux of ROIC, and it is a part that cannot be replaced by other indicators.

It is that number used in investment screening.

Moreover, this line is not a story from a distant world. In many cases, the hurdle rate for investment screening is based on this WACC.

When considering an investment project, you calculate the IRR (Internal Rate of Return), right? It is the expected yield of how much that project will return. You compare that to the hurdle rate, and if it exceeds it, you invest.

• WACC 6%, Project IRR 9% → Approved

• WACC 6%, Project IRR 4% → Not approved

The reason is simple: the money used for that investment was also procured at a cost of 6% per year. If you invest in something that only returns 4%, a net loss is guaranteed the moment you execute it.

(In practice, I think many companies set the hurdle at a level that adds a few percent to the WACC to account for overly optimistic projections.)

What I want you to notice here is that IRR and ROIC use the same yardstick.

• IRR vs. Hurdle Rate … The prospect for a single project about to be invested in

• ROIC vs. WACC … The actual results of everything already invested in

Looking at the entrance and the exit with the same WACC. When organized that way, the two connect.

And this kind of thing can happen: Even though all individual projects are approved for exceeding the hurdle, the company-wide ROIC is below the WACC. It means that somewhere, the projections are not becoming reality. It can also be read as a sign that post-investment verification is not working.

4. However, ROIC is not omnipotent

If you are in a position to explain it, I think you will be trusted more if you also convey its limitations. I will list four.

If you reduce the denominator, the number goes up

It takes time to increase profit, but reducing invested capital has an immediate effect. Tightening inventory, postponing capital investment, stopping renewals. Next period's ROIC will definitely go up. And a few years later, you realize you have lost competitiveness. It is a shrinking equilibrium.

Investments for the future are the ones that worsen ROIC in the short term

Most R&D and human resource development expenses are treated as expenses when incurred. Since they do not appear on the balance sheet, they are not reflected in the denominator, and only the numerator decreases.The more you invest in the future, the worse your current figures will look.

It is a rate, not an amount

Suppose a company with an average company-wide ROIC of 15% is presented with an investment project with an ROIC of 10% (WACC is 6%). Even though this project will definitely create value, it might be rejected simply because it would "lower the average." You need to look at the rate (ROIC) and the amount (EP) as a set.

Cannot be compared horizontally with other companies

The definition of invested capital varies from company to company. Whether to deduct all cash and deposits or leave the necessary amount, whether to include goodwill, and how to handle lease assets. Even with the same "ROIC of 8%," the contents are not consistent.

There are also significant differences between industries. In retail or food service, where accounts payable are high, working capital can sometimes be negative, and service industries that hold almost no fixed assets will show a higher ROIC because the denominator is small.

Therefore, an argument like "Company A in the same industry is at 10%, but we are at 7%" might just be looking at differences in definitions or industries.

The party you should be comparing against is not another company. It is your own WACC and your own time series.

5. Where does AI investment appear in ROIC?

Finally, let's apply this to the issues many companies are currently facing.

When it appears in the numerator (profit)

I previously wrote an article about where the time saved by AI implementation falls in the P&L. Time saved only becomes profit when it is applied to avoiding additional hiring, reducing outsourcing costs, reducing overtime pay, or increasing sales. Time saved that is not applied to these does not move the numerator by even one yen.

When it appears in the denominator (invested capital)

This is what is easily overlooked.

• Cloud/SaaS: Since usage fees are treated as expenses, the denominator does not increase much (customization costs at the time of implementation may sometimes be capitalized).

• In-house development/GPU equipment: If capitalized, the denominator increases, and ROIC will drop until operations are up and running.

• M&A of AI-related companies: Goodwill is added to the denominator. The acquired business will be structurally disadvantaged.

• Demand forecasting/inventory optimization: If inventory decreases, working capital decreases, and the denominator directly shrinks. This is the most effective.

Even with the same "AI investment," there is a mix of things that affect the numerator, things that increase the denominator, and things that decrease the denominator. If you evaluate them all together using ROIC, you might make the wrong judgment.

And the most valuable parts, such as AI utilization know-how and human skill, do not appear on the BS. They remain off the denominator and push down the numerator as expenses. The point from the previous section, "the more you invest in the future, the worse your current figures will look," applies exactly here.

6. Checking your company's implementation

Even in companies that are already using ROIC, you may find gaps when you re-examine the process.

• [ ] Is the definition of invested capitalconsistent across the company? (Treatment of cash and deposits, goodwill, and lease assets)

• [ ] Is the WACC figureshared company-wide? Is it consistent with the hurdle rate for investment screening?

• [ ] Is the unit for calculating ROICa unit that allows for investment and withdrawal decisions?

• [ ] In budget formulation, are inventory, trade receivables, and equipment discussed with the same weightas the P&L?

• [ ] Has the goal become one that can be achieved solely by reducing the denominator?

• [ ] Is there a mechanism to look at the amount (EP) as well as the rate (ROIC)?

If KPIs are handed down to the front lines while the first two points remain ambiguous, the discussion will return to square one every time.

Conclusion

ROIC is a metric that introduces the perspective of "capital" to an organization that operates in the language of P&L.Just because a profit is being made does not necessarily mean it is good. If this can be conveyed, I believe the explanation is half successful.

However, the longer a metric is used, the more it takes on a life of its own. It goes up if you reduce the denominator, and it worsens the more you invest for the future. While it continues to be set as a target value, no one explains why that metric is used—this may be the scariest part.

When we talk about sustainability, it tends to be about the environment or society, but whether a business can continue is decided much earlier. This is because a business that continues to fall below the cost of capital will eventually be unable to sustain investment, hiring, or R&D. In terms of order, this comes first.

And now that the era of low interest rates is over, the line that must be crossed has risen.

Continuing to exceed WACC. I believe that is the most understated form of sustainability in an era with interest rates.

How has your company's WACC moved compared to five years ago?

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