Capital Employed

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 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.

Key Takeaways

  • 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.
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Capital Employed

Formula and Calculation of Capital Employed

 Capital employed = Total assets Current liabilities \begin{aligned} \text{Capital employed} &= \text{Total assets} - \text{Current liabilities} \\ &=\text{Equity} + \text{Noncurrent liabilities} \end{aligned} Capital employed=Total assetsCurrent 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 non-current liabilities, meaning long-term liabilities.

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 2021.

(in $millions) Alphabet Apple Microsoft
EBIT $41,047 $65,339 $69,916
Total Assets (TA) $319,616 $323,888 $333,779
Current Liabilities (CL) $56,834 $105,392 $88,657
TA - CL $262,782 $218,496 $245,122
Return on Capital Employed 0.1562 0.2990 0.2852

Of the three companies, Apple Inc. has the highest return on capital employed of 29.9%. A return on capital employed of 29.9% means that for every dollar invested in capital employed for 12 months ended September 30, 2021, the company made almost 30 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.

What Is a Good Return on Capital Employed?

In general, the higher the return on capital employed (ROCE), the better it is for a company. The ROCE calculation shows how much profit a company generates for each dollar of capital employed. The higher the number (which is expressed as a percentage), the more profit the company is generating.

One way to determine if a company has a good return on capital employed is to compare the company's ROCE to that of other companies in the same sector or industry. The highest ROCE indicates the company with the best profitability among those being compared.

Another way to determine if a company has a good ROCE is to compare it to the returns from previous years. If the ratios are trending down over a span of several years, it means the company's profitability levels are declining. Conversely, if ROCE is increasing, this means the company's profitability is increasing as well.

What Is Return on Average Capital Employed?

Return on average capital employed (ROACE) is a ratio that measures a company's profitability versus the investments it has made in itself. To calculate ROACE, divide earnings before interest and taxes (EBIT) by the average total assets minus the average current liabilities. ROACE differs from the return on capital employed (ROCE) because it takes into account the averages of assets and liabilities over a period of time.

How Do You Calculate Capital Employed From a Company's Balance Sheet?

First, find the net value of all fixed assets on the company's balance sheet. You'll see this value listed as property, plant, and equipment (PP&E). To this number, add the value of all capital investments and current assets. From this number, subtract all current liabilities. These include all financial obligations due in a year or less. Examples of current liabilities listed on a company's balance sheet include accounts payable, short-term debt, and dividends payable.

Article Sources

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