Why Tanla Solutions Limited’s (NSE:TANLA) Return On Capital Employed Might Be A Concern

Today we’ll look at Tanla Solutions Limited (NSE:TANLA) 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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.’

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 Tanla Solutions:

0.011 = ₹90m ÷ (₹9.7b – ₹2.7b) (Based on the trailing twelve months to September 2018.)

Therefore, Tanla Solutions has an ROCE of 1.1%.

Check out our latest analysis for Tanla Solutions

Is Tanla Solutions’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Tanla Solutions’s ROCE appears to be significantly below the 10% average in the Software industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Tanla Solutions stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Tanla Solutions’s current ROCE of 1.1% is lower than its ROCE in the past, which was 3.1%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

NSEI:TANLA Last Perf January 8th 19
NSEI:TANLA Last Perf January 8th 19

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. How cyclical is Tanla Solutions? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Tanla 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.

Tanla Solutions has total assets of ₹9.7b and current liabilities of ₹2.7b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

Our Take On Tanla Solutions’s ROCE

Tanla Solutions has a poor ROCE, and there may be better investment prospects out there. But note: Tanla Solutions may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.