What Is Capital Employed?
Capital employed, also known as funds employed, is the total amount of capital used for the acquisition of profits by a firm or project. Capital employed can also refer to as the value of all the assets used by a company to generate earnings.
By employing capital, companies invest in the long-term future of the company. Capital employed is helpful since it's used with other financial metrics to determine the return on a company's assets as well as how effective management is at employing capital.
Formula and Calculation of Capital Employed
Capital employed=Total assets−Current liabilities
Capital employed is calculated by taking total assets from the balance sheet and subtracting current liabilities, which are short-term financial obligations.
Capital employed can be calculated by adding fixed assets to working capital; or by adding equity–found in shareholders' equity section of the balance sheet–to noncurrent liabilities, meaning long-term liabilities.
- Capital employed is derived by subtracting current liabilities from total assets; or alternatively by adding noncurrent liabilities to owners' equity.
- Capital employed tells you how much has been put to use in an investment.
- Return on capital employed (ROCE) is a common financial analysis metric to determine the return on an investment.
What Capital Employed Can Tell You
Capital employed can give a snapshot of how a company is investing its money. However, it is a frequently used term that is at the same time very difficult to define because there are so many contexts in which it can be used. All definitions generally refer to the capital investment necessary for a business to function.
Capital investments include stocks and long-term liabilities. It also refers to the value of assets used in the operation of a business. In other words, it is a measure of the value of assets minus current liabilities. Both of these measures can be found on the balance sheet. A current liability is the portion of debt that must be paid back within one year. In this way, capital employed is a more accurate estimate of total assets.
Capital employed is better interpreted by combining it with other information to form an analysis metric such as return on capital employed (ROCE).
Return On Capital Employed (ROCE)
Capital employed is primarily used by analysts to determine the return on capital employed (ROCE). Like return on assets (ROA), investors use ROCE to get an approximation for what their return might be in the future. Return on capital employed (ROCE) is thought of as a profitability ratio. It compares net operating profit to capital employed and tells investors how much each dollar of earnings is generated with each dollar of capital employed. Some analysts prefer return on capital employed over return on equity and return on assets since it takes long-term financing into consideration, and is a better gauge for the performance or profitability of the company over a longer period of time.
A higher return on capital employed suggests a more efficient company, at least in terms of capital employment. A higher number may also be indicative of a company with a lot of cash on hand since cash is included in total assets. As a result, high levels of cash can sometimes skew this metric.
Return on capital employed is calculated by dividing net operating profit, or earnings before interest and taxes (EBIT), by employed capital. Another way to calculate it is by dividing earnings before interest and taxes by the difference between total assets and current liabilities.
Example Of How to Use Capital Employed
Let's calculate the historical return on capital employed by three tech companies—Alphabet Inc., Apple Inc., and Microsoft Corporation—for the fiscal year ended 2017.
|Total Assets (TA)||$147,461||$375,319||$241,086|
|Current Liabilities (CL)||$19,310||$100,814||$64,527|
|TA - CL||$128,151||$274,505||$176,559|
|Return on Capital Employed||0.1894||0.2419||0.1662|
Of the three companies, Apple Inc. has the highest return on capital employed of 24.19%. A return on capital employed of 24.19% means that for every dollar invested in capital employed for 12 months ended September 30, 2017, the company made 24 cents in profits. Investors are interested in the ratio to see how efficiently a company uses its capital employed as well as its long-term financing strategies.