What Is Capital Employed?
Capital employed indicates the investment in the business, the total amount of funds used for expansion or acquisition by a firm, and the total value of assets dedicated towards the business and is calculated by subtracting current liabilities from total assets or by adding working capital to fixed assets.
It represents the amount invested in the business to generate returns. It helps the business to expand and grow to earn profit, which depicts its financial health. It is important to keep track of how the capital that is employed, is being used, so that there is no misappropriation of wastage. It is an important resource to help the entity run smoothly.
Table of contents
Capital Employed Explained
In simple words, capital employed is the total funds deployed for running the business with the intent to earn profits and is usually calculated in two ways a) Total Assets minus Current Liabilities or b) Non-Current Assets + Working Capital.
What type of formula the business will choose to calculate the same, depends on its nature and size, type of industry or sector, industry standards and the method usually followed by similar companies to maintain uniformity, etc.
The fund that is employed into the business may be in the form of debt or equity or both in certain proportion. Debt means the company as borrowed funds from lenders and investors in the form of loan which it will have to repay with a time period along with interest. Equity on the other hand is the money that investors contribute in order to get ownership right in the business, by subscribing to its stocks. It includes preferred and common stocks, retained earnings or any other form of equity related items.
A higher value of Capital Employed, especially when a significant chunk of it is not sourced from shareholders’ equity, indicates a higher risk level. Though the higher level of risk might make investors wary of investing in the company, it also hints at aggressive business expansion plans, which, if successful, could result in much higher returns on investments.
Investors who put their money into a business tend to keep track of its performance and expect a return on the funds.
Thus, the , average capital employed is an source of information regarding how much capital is available to run the business operation smoothly and helps in evaluation of its performance.
Let us look at the formula used for capital employed calculation.
- Here total assets include fixed assets at their net value. Some prefer to use the original cost, but others use replacement cost after depreciation.
- This is added to any Cash in hand, cash at the bank, bills receivable, stock, and other current assets.
- Finally, all capital investments in businessCapital Investments In BusinessCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc. operations are added to these items to arrive at the value of total assets in this calculation.
- Next, subtract current liabilities from the value arrived at for total assets to perform the capital employed calculation.
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Another capital employed equation is given below.
Non-current assets are long-term assets whose full value cannot be realized within the current financial year. It typically includes fixed and intangible assets, brand recognition, and intellectual property. This formula also includes any investments made in other businesses.
Working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)" can be defined as a quick measure of the operational efficiency of a company and its overall financial health.
Working Capital = Current Assets – Current Liabilities.
All of the figures utilized for Capital Employed calculationCapital Employed CalculationCapital employed indicates the company's investment in the business, i.e., the total amount of funds used for expansion or acquisition and the entire value of assets engaged in business operations. "Capital Employed = Total Assets - Current Liabilities" or "Capital Employed = Non-Current Assets + Working Capital." can be found on the balance sheet of the company.
Calculation using 1st Formula
- To calculate this for Company ABC based on the first method, we look for the figure against “Total assets.” Let us suppose it is $42000000.
- Next, we look for the figure against “Total Current Liabilities,” as listed in the balance sheet. Let us suppose this figure is $25000000.
Now, we calculate like this using the capital employed equation:
- CE = Total Assets ($42000000) – Current Liabilities ($25000000) = $17000000
Calculation using 2nd Formula
The second method would require looking up the following measures on the capital employed in balance sheet of Company ABC, non-current assets, current liabilities, and current assets. We can find both current and noncurrent assets listed in the Assets section of the balance sheet and current liabilities in the Liabilities section.
- Let us suppose, Non-Current Assets = $105 Million
- Current Liabilities = $54 Million
- Current Assets = $65 Million
- Now, we calculate like this:
- CE = Non-Current Assets ($105000000 + Working Capital (Current Assets ($65000000) – Current Liabilities($54000000))
- = $105 Million + $11 Million = $116 Million
Use And Relevance
Let us study the uses of the concept.
Generally, it is put to good use in estimations on how well a company might be using its capital to enhance its profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.. It is achieved by calculating Return on Capital EmployedReturn On Capital EmployedReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed.
EBIT is also known as operating incomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business., divided by the figure for employed capital to get ROCE. It is especially useful in comparing capital utilization in companies operating in capital-intensive industries.
The average capital employed helps the analysts and investors decide the type of capital structure of the business, which is turn gives them an idea about how much is debt and how much is equity. This speaks about the repayment obligation which is a risk because money will flow out of the business.
The capital allocation gives an idea about how much fund is available for investment that will generate enough return for it to become profitable and sustainable in future. This will lead to growth and expansion.
You can use the following Calculator
|Capital Employed Formula =||Total Assets – Current Liabilities|
|0 – 0 =||0|
Capital Employed in Excel (with excel template)
It is straightforward. In the first method, You need to provide the two inputs of Total Assets and Total Current Liabilities. And in the second method, you need to provide the three inputs of Non-Current AssetsNon-Current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark., Current Liabilities, and Current Assets.
Calculation by First Method
Calculation by Second Method
You can download this template here – Capital Employed Excel Template
Video on Capital Employed Ratio
Capital Employed Vs Invested Capital
Both the above are two financial terms that denote the amount of capital in the business but their nature and use is different from each other. Let us study the differences in the above two terms in detail.
- The former shows the amount of money that is present in the business and which will be used for operational purpose and the latter shows that fund that is in circulation within the business.
- The capital employed in balance sheet explains the amount of fund in the business which is expected to generate a particular return every year, but the latter represents the money put into various areas of the business to meet its financial obligations and which will help to run it smoothly.
- The former has two components, mainly the equity, which is the ownership interest of the investors into the business and the debt, which is the long term loan obligation. For the latter, components include the avenues where the capital is invested like various projects for long and short term, money put in development of infrastructure of the entity, which may be technological advancement, skill development through training, purchase of higher quality plant and machinery, etc.
However, the return on both the cases will represent how well the company is able to utilize its funds for betterment of the operations.
This article has been a guide to what is Capital Employed. We explain it with formula, differences with invested capital along with example & uses. You may also refer to the following to learn more about Financial Ratios.
- Book Value FormulaBook Value FormulaThe book value formula determines the net asset value receivable by the common shareholders if the company dissolves. It is calculated by deducting the preferred stocks and total liabilities from the total assets of the company.
- Current Assets List
- Types of Current Assets Examples
- Current Assets FormulaCurrent Assets FormulaThe formula for current assets is derived by adding all of the assets on the balance sheet that can be converted to cash in less than a year. Cash, cash equivalents, account receivables, inventories, marketable securities, prepaid expenses, and other current assets are the most common.