**Capital Employed Formula (Table of Contents)**

## What is Capital Employed Formula?

In a layman’s language, Capital employed may be defined as the amount invested in the business to earn profits. Considering technical definition, capital employed may be defined as resources/funds employed in a business/project to fetch profits from such resources. Capital employed is the sum total of fixed assets and current assets reduced by current liabilities.

**Capital Employed Formula**

Capital employed can be calculated using two formulas:

**Asset Side Approach**

**Capital Employed Formula = Total Assets – Current Liabilities**

Sum total of fixed assets and working capital. Working capital can be calculated by reducing current liabilities from current assets.

**Liabilities Side Approach**

**Capital Employed Formula = Equity + Reserve & Surplus + Non Current Liabilities**

Sum total of equity and noncurrent liabilities. Here equity includes capital invested in the business and reserve & surplus of the business.

**Explanation of Capital Employed Formula **

Capital employed as stated in the definition is the amount invested in the business to earn profits. Capital employed is the basic step in the calculation of various other ratios and analyzing company performance for a given period of time.

The most common ratio calculated using capital employed is Return on Capital Employed (ROCE). Return on capital employed formula means net operating profit earned by the organization for capital employed in the business. Investors prefer to use capital employed ratio since it considers the long term sources of finance as part of investment over return on equity. This ratio is useful for both providers of long term finance as well as investors in the share capital of the company.

Explanation of figures required in capital employed

**Non-Current Assets**

Non-current assets include assets held for more than one year such as tangible fixed assets: building, land, plant & machinery, furniture & fixture as well as intangible fixed assets such as patent, know-how, trademarks

**Current Assets**

Current assets include assets held for a maximum period of one year such as cash, bank balance, inventory, debtors and other assets receivable or recoverable in a period of one year.

**Current Liabilities**

Current liabilities are the obligation of an organization that has to be settled within a period of one year such as creditors, short term loans and expenses payable short term provisions that are liable to repay in a period of one year.

**Examples of Capital Employed Formula **

Let’s see some simple to advanced practical examples of capital employed equation to understand it better.

**Capital Employed Formula – **Example #1

**Company Gama started its operations last in year in FMCG products. It wants to raise funds through the issue of share capital and long term loans. The company’s senior accountant wants to know the company’s performance in the past year by calculating the return of capital employed. **

**For this, he wants to know the capital employed in the business by the company. Following historic date has been shared by him for capital employed calculation.**

**Solution**

First of all, we will calculate, a total asset of the company

**Calculation of Total Assets**

- Total Assets = Non-current Assets+ Current Assets
- =2605000+1435000

Total Assets will be –

**Total Assets = 4,040,000**

Calculation of Capital Employed

- =4040000-1365250

**Capital Employed will be –**

**= 2,674,750**

So, the company has invested $2,674,750 is its FMCG business to earn profits.

**Capital Employed Formula – **Example #2

**Taking the concept of capital employed ahead, we will calculate capital employed as well as return on capital employed. Company Blazing Sunburns shares his historic date from last year and desires calculation of capital employed and return on capital employed (ROCE). Extract of the Balance sheet shows the following figure:**

**Solution**

This question can be solved by using both the asset side approach as well as the liability side approach:

We will solve this problem using both approaches.

**Using the Asset Side Approach**

Calculation of Capital Employed

- =5380000-760000

**Capital Employed will be –**

**=4,620,000**

**Using Liability Side Approach**

Calculation of Capital Employed

= 3565000+1055000

Capital Employed will be –

- =4,620,000

In the above example suppose the net operating profit of the company is $1,468,750 so ROCE can be calculated as follows:

Calculation of ROCE using below is as follow,

ROCE = Net Operating Profit / Capital Employed

- = 1,468,750 / 4,620,000
- =
**0.3179**

**Capital Employed Formula – **Example #3

**Taking another example to understand the benefit of using a capital employed formula in practical life, Suppose Company Moonlight has made a profit of $ 1,625,000 after payment of interest and taxes and it has outstanding long term loans amounting to $ 6,520,000 bearing a 9% rate of interest. The company has $ 3,865,000 as issued share capital. The company has retained earnings of $ 1,236,000. **

**The company comes in a tax bracket of 35%. Company Beta and Gama operate in the same industry have calculated its ROCE as 0.5627 and 0.4326 respectively. You need to calculate return on capital employed for the company and compare it with other company standards and draw a conclusion.**

**Solution**

For the calculation of return on capital employed we need to first calculate capital employed and net operating profit for the company.

Calculation of Profit before Interest & Tax

- =2500000.00+586800.00
**=3086800.00**

Calculation of Return on Capital Employed (ROCE)

- =3086800.00/11621000.00
**=0.26562258**

Comparison table for ROCE of different companies in the same industry.

The above table shows that company Beta has the highest ROCE which means that for every $ invested by company beta they get a return of $0.5627.

Closely looking at the balance sheet figures of company moonlight, they are financed more through long term loans instead of share capital which clearly shows that the company is a risk-taking company and this will restrict the investors from investment.

### Relevance and Use

As we discussed above, the capital employed equation is the basic step in the calculation of various other formulas and analyzing the information is a financial statement. The capital employed equation is helpful for both companies as well as investors. The primary use of the capital employed formula is to calculate the return on capital employed used by the company and analysts to understand the performance of the company.

The company can analyze its performance by calculating return on capital employed to get a better picture of their profits and compare it with industry standards. Are they outperforming or require a change in their strategies?

On the other hand, the investor uses the capital employed formula to evaluate the company’s abilities to earn the amount invested in the business. The investor can make a decision that should they invest in that particular business idea.

### Recommended Articles

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