Invested Capital Definition
Invested capital represents the total amount which is currently invested in the business, regardless of its source and is calculated as the sum total of the investments from shareholders and debt-holders (including the capital lease obligations). It is the source of the funds for the company which can be used for many purposes but at the same time, it is also the liability for the company as it has to repay the money along with the reasonable rate of return back to both shareholders and the debt-holders.
Invested Capital Formula
There are two different formulas which includes the following:
#1- Financing approach
Formula using the financing approach is mentioned below:
#2 – Operating approach
Formula using the operating approach is mentioned below:
Where Net Working Capital = Current operating asset – Non-interest bearing Current Liability.
Interpretations & Examples of the Invested Capital
Below are some examples.
For example, there is a company XYZ Ltd. which is having the following information:
Using these values calculate the invested capital of the company using the operating approach.
We will calculate the following values first,
Net Working Capital
- Networking capital = Current operating asset – Non-interest bearing current liability
- = $ 15,000– $8,000
- = $ 7,000
- Tangible assets = Plant and equipment + Present Value of the non-capitalized lease obligations
- = $ 25,000+ $ 1,500
- = $ 26,500
- Intangible assets = Goodwill
- = $ 6,000
So, the calculation using financing approach is as follows,
- = $ 7,000 + $ 26,500 + $ 6,00
- = $39,500
There is a company ABC ltd., having the following information:
Calculate the invested capital of the company using the financing approach.
Short term debts = $ 50,000
Long term debts = $ 30,000
- All leases = Present Value of the non-capitalized lease obligations
- = $1,500
Total Equity & Equity Equivalents
- Total equity and the equity equivalents = Common stocks + Additional paid-in capital + Retained earnings.
- = $ 10,000 + $ 50,000 + $ 40,000
- = $ 100,000
So the calculation using financing approach is as follows,
- = $ 50,000 + $ 30,000 + $1,500 + $ 100,000
- = $ 181,500
Some of the advantages are as follows:
- For a company, it is the source of fund which allows the company to take new opportunities like new project expansion, etc.
- It can be used for covering the day to day operating expenses of the company like employee salary expenses.
- Investors who have invested their money in the company use this for calculating ROIC ratio. The ratio calculated is used by the investor for determining the value of the company. When there is a high ratio of ROIC then it indicates that the company is able to utilize the invested funds for generating a higher profit compared to other companies.
- With the help of the invested capital ability of a company to generate sales through the capital can be calculated by dividing the sales by the capital invested. A higher ratio means the company is more efficient.
- When the calculations are not done correctly then it could give the wrong data of capital.
- If the data is not correct then all the ratios which are calculated on the basis of the invested capital will also give the wrong results to the investors of the company.
- Invested capital of the company is the capital contributed by the debt-holders and shareholders of the company
- The debt-holders are the persons who have purchased the bonds of the company and the shareholders are the persons who have purchased the stocks of the company.
- There are two different ways to calculate it, which includes financing approach and the operating approach.
- It is helpful for the company as it is the source of fund which allows the company to take new opportunities like new project expansion etc. Also, it is useful for the investors as it helps in calculating the return on the invested capital ratio and ability of a company to generate sales through the capital.
Thus it can be concluded that the invested capital represents the total amount which is currently invested in the business, regardless of its source. It is one of the important when it is to determine whether the company is earning the profit which is required by the investors of the money in the company as the cost of using money. There are two approaches i.e., financing approach and the operating approach using which it can be calculated.
This has been a guide to what is invested capital and its definition. Here we discuss how to interpret invested capital along with examples, advantages, disadvantages etc. You can learn more about financing from the following articles –