Capital employed represents all the capital your business needs to function. More than simply a measure of the assets you own, it includes all the capital you use to acquire profit such as cash in the bank, shares of stock and the invoices you've billed to customers. Capital employed is not directly visible from the company's financial statements, but you can easily compute it using figures found on the balance sheet.
TL;DR (Too Long; Didn't Read)
Calculate capital employed by subtracting current liabilities from total assets, or by adding equity to loans that are subject to interest.
What Is Capital Employed?
Capital employed is a catch-all phrase that's used in many contexts, and there isn't a universal definition of what it means and how you should calculate it. Generally, though, it's the total of all the long-term sources of capital that are necessary for your business to function. Examples include cash in hand, cash in the bank, shares of stocks, trade receivables, the value of assets used in the business and other long-term liabilities. You can find all the figures you need to calculate capital employed on the company's balance sheet.
How Do You Calculate Capital Employed?
The simplest capital employed formula takes the business's total assets and deducts current liabilities using the following formula:
Capital employed = total assets – current liabilities
"Total assets" appears as a line item on the balance sheet. It comprises the net value of fixed assets, intangible assets such as goodwill and trade names, cash in the bank, cash on hand, bills receivable, other current assets and all the capital investments of your business operations. For example, if the total assets are $800,000 and the "total liabilities" line item on the balance sheet is $225,000, you would subtract the total liabilities from the total assets to arrive at the capital employed, which is $575,000.
CE = total assets ($800,000) – current liabilities ($225,000) = $575,000
Another Capital Employed Example
A second capital employed (CE) calculation focuses on the liabilities side of the balance sheet using the following formula:
Capital employed = equity + noncurrent liabilities
Equity is the share capital listed on the company's balance sheet. Non-current liabilities comprise retained earnings plus long-term borrowings that are not due for settlement within one year. Examples include long-term loans, deferred-tax liabilities and debentures. These liabilities are classified separately in a company's balance sheet, away from current liabilities.
As an example, suppose that stockholders' equity totals $85,000 and non-current liabilities total $125,000.
CE = equity ($85,000) + non-current liabilities ($125,000)) = $210,000
What It All Means
When you employ capital, you are investing in the business. A higher value of employed capital suggests that the business is using all the capital available to it, perhaps as part of an aggressive expansion plan. This may be risky in the short-term but could result in much higher returns in the long-term. Investors would weigh these factors before investing in the company. More significantly, a business can use CE to understand the Return on Capital Employed, calculated by dividing EBIT – earnings before tax and interest, also known as operating income – by capital employed. ROCE estimates how well the company is using its capital to enhance its profitability, which is useful when evaluating the efficiency of companies that work in capital-intensive industries.
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