Return on Research Capital (RORC)

Meaning and definition of Return on Research Capital

The return on research capital (RORC) is a calculation used to assess the revenue earned by a company as an outcome of expenditures made on research and development activities. The return on research capital is an element of productivity and growth, as research and development is one of the techniques employed by the companies to develop new products and services for sale. This metric is generally used in industries that depend largely on R&D like the pharmaceutical industry.

As stated by Investopedia, companies face an opportunity cost while evaluating the use of their funds. They can spend money on tangible assets, capital improvements or real estate, or they may also invest in R&D. Investments made in research might take several years before tangible assets are seen, and the return generally varies between industries and even within the sectors of a specific industry.

Calculating the Return on Research Capital

The return on research capital indicates the gross profit generated for each dollar of R&D spent in the past year. The procedure of calculating the Return on Research Capital is quite simple. The process includes the current year’s gross profit (in dollars) being divided by the R&D expense incurred in the past year.

The general formula used for computation is:

RORC = Current Year Gross Profit / Previous Year R&D Expenditures

The numerator, or gross profit, is usually positioned on the current year’s income statement. At times, companies decide not to unequivocally state the gross profit on the income statement. In that case, the gross profit can be derived by deducting the cost of goods sold from revenues.

In the interim, evaluate the R&D expenses on the income statement. However, because of inconsistencies between GAAP and IFRS accounting standards, they can also be capitalized on the balance sheet. Even though the two methods congregate, there are incongruities which are considered as an expense or an asset.

However, using gross profit in place of operating profit, or net profit as the gross profit, perhaps offers the best representation of the incremental profitability produced by the research and development efforts of a company. Also, this calculation presumes a one-year average investment cycle for R&D. Thus the previous year’s R&D expenditure gets converted into present year’s new technology products, generating current year’s profits.