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Capital employed is sometimes referred to as funds employed. It refers to the capital that a business uses in order to generate profits or to the combined value of the assets that a business makes use of in order to generate income. Any business that is serious about enjoying a successful long-term future will need to invest capital in that future.
The value of any capital employed formula is that it can be combined with other measurements to ascertain how well the company’s assets are being employed and whether the management is deriving maximum benefit from any capital put into the business.
The value of knowing capital employed
By calculating the capital employed within a business it is possible to create a snapshot of the efficiency with which that business is investing its money. These capital investments could include stocks and long-term liabilities, although the capital employed calculation also produces a simple measure of the value of assets held by the business against the current liabilities that need to be paid back within a year.
In other words, a capital employed calculation will make it plain whether a business has the assets needed to cover all its debts that might fall due within a relatively short period of time. If this is not the case then the capital employed calculation has revealed that the business has not been investing its capital in a particularly effective manner.
The capital employed method in full
Although capital employed should be combined with other aspects of a company balance sheet to ascertain the wider picture of how a business is performing, it is an extremely useful and relatively simple calculation to make and involves the following steps.
Take the balance sheet of the company and ascertain the value of all fixed assets. These will be listed in the non-current asset section of the balance sheet, and are often referred to as property, plant and equipment (PP&E). All fixed assets of this kind, except for land, must be included in the balance sheet with their depreciated value – reflecting the degree to which the value of the asset has dropped since it was purchased.
Once the value of fixed assets is known, you need to add capital investments. This includes any investments made by financial institutions, private individuals or venture capital funds. Once the capital investments have been calculated, the current assets need to be added to the value. These items will be listed in the balance sheet assets section and include those that could be converted into cash within a 12-month period.
The figure used to arrive at the value of these assets can be the purchase price, although some companies use the cost after depreciation, which complicates the calculation but gives a more accurate picture. Current assets should also include any cash held by the business – in hand or in business bank accounts – as well as the value of stock held and bills receivable. Once all assets have been combined the calculation is as simple as subtracting short-term financial obligations such as accrued expenses, short-term debt, and accounts and dividends payable.
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