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Capital employed is essentially the capital a business uses to generate profit. It can be calculated using the capital employed formula. In this post, we’ll define capital employed more clearly, outline the formula used to measure it, and also briefly explore what’s meant by return on capital employed.
What is capital employed?
Capital employed, sometimes known as funds employed, is the total amount of capital a company uses to acquire profits. It can also refer to the monetary value of assets used by a company to generate profit.
Employing capital is an essential step for companies that envision a long future. Along with other financial metrics, capital employed can be used to gauge the return on company assets and give a good indication of how effectively a business is investing its capital.
What is the capital employed formula?
Capital employed can be calculated using two different formulas.
The most common formula used is the following:
Here, total assets refers to the total value of all assets. Current liabilities, meanwhile, refer to liabilities due within 12 months.
Below is another formula used:
Here, fixed assets, which are sometimes called capital assets, are assets purchased for long-term use and are essential to the run-in of the company. This might include property or equipment, for example.
Working capital, meanwhile, is the capital accessible for daily operations. It’s calculated by subtracting current liabilities from current assets.
It’s important that whichever formula is used is used consistently. In fact, switching between formulas can skew your results.
Interpreting capital employed
The capital employed metric gives insight into how effectively a company is investing its money in order to generate profits. While this figure may differ according to the formula used, it can nonetheless provide a fairly dependable indication.
The calculation can also provide a straightforward measure of the value of a business’ assets proportional to its current liabilities.
Put in different terms, a capital employed calculation can make it clear whether a business has the assets it requires to cover any debts. If it transpires that it doesn’t, then the calculation has revealed that the business has not effectively invested its capital.
To paint a fuller picture of capital investment in a company, analysts will additionally look at earnings before interest and tax (EBI) and return on capital employed (ROCE).
Return on capital employed formula
Return on capital employed (ROCE) is a ratio which demonstrates the profitability of a company as well as the efficiency with which it has used its capital. ROCE is considered a highly valuable profitability ratio as it reveals the operating income made per dollar of invested capital.
Below is the formula for ROCE:
What is a good return on capital employed?
Generally speaking, the greater the return on capital employed (ROCE), the better it is for a company. This means that the higher the ROCE, the more profit a company generates proportional to its capital employed.
To determine whether or not your company has a good return on capital employed, it’s best to compare your ROCE to other companies operating within the same sector. The company with the highest ROCE will be generating the largest profit.
Capital employed summarised
Capital employed is calculated by subtracting current liabilities from total assets
Capital employed reveals how much capital has been invested, and how effectively.
Return on capital employed (ROCE) is a popular financial analysis metric used to show the return on investments and therefore profitability.
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