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A:

A company's balance sheet offers a snapshot of how a company utilizes its capital resources at a given point in time. To perform a capital-employed analysis, focus on funds being used during the operating cycle and from where those funds come. The most important items to identify are fixed assets, inventories, trade receivables and payables.

Capital employed is financed by capital invested. Pay attention to shareholders' equity, net debt and other long-term assets and liabilities. This provides a sense of future capital flexibility.

Capital Employed Analysis

Capital employed is a catch-all phrase. No fixed or universal definitions explain what capital employed means – or, rather, different definitions are based on different contexts.

The simplest presentation of capital employed is total assets minus current liabilities. Sometimes, it is equal to all current equity plus interest-generating loans (non-current liabilities).

Fundamental investors most frequently refer to capital employed as part of the return on capital employed (ROCE) or return on average capital employed (ROACE) metrics. ROCE and ROACE compare the company's profitability to the total investments made in new capital.

Some consider capital employed as long-term liabilities plus share capital plus profit and loss reserves. In this circumstance, net assets employed is always equal to capital employed.

Simple Method

The simple method of determining capital employed by looking at a balance sheet involves four steps:

• Locate the net value of all fixed assets. It's easiest to use original cost, but some prefer to use replacement cost after depreciation.

• Add all capital investments into the business.

• Add cash in hand, cash at bank, bills receivable, stock and other current assets.

• Subtract current liabilities.

Check out the answer to our FAQ - What does a high capital employed imply about risk?

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