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What is 'Capital Employed'

Capital employed, also known as funds employed, is the total amount of capital used for the acquisition of profits. It is the value of all the assets employed in a business, and can be calculated by adding fixed assets to working capital or by subtracting current liabilities from total assets. By employing capital, you make an investment.

BREAKING DOWN 'Capital Employed'

Capital employed is a frequently used term but is 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. Put simply, 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.

The general formula used for computing capital employed is:

Capital Employed = Total Assets - Current Liabilities = Equity + Noncurrent Liabilities

Return on Capital Employed

Capital employed is primarily used by analysts to determine the return on capital employed (ROCE). Like return on assets, 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.

Let's calculate the return on capital employed by three tech companies - Alphabet Inc., Apple Inc., and Microsoft Corporation - for the fiscal year ended 2017.

(in millions) Alphabet Apple Microsoft
EBIT $24,274 $66,412 $29,339
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.

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