The capital used by a company to generate profits
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What is Capital Employed?
Capital employed refers to the amount of capital investment a business uses to operate and provides an indication of how a company is investing its money. Although capital employed can be defined in different contexts, it generally refers to the capital utilized by the company to generate profits. The figure is commonly used in the Return on Capital Employed (ROCE) ratio to measure a company’s profitability and efficiency of capital use.
Formula
This metric can be calculated in two ways:
Capital Employed = Total Assets – Current Liabilities
Where:
- Total Assets are the total book value of all assets.
- Current Liabilities are liabilities due within a year.
or,
Capital Employed = Fixed Assets + Working Capital
Where:
- Fixed Assets, also known as capital assets, are assets that are purchased for long-term use and are vital to the operations of the company. Examples are property, plant, and equipment (PP&E).
- Working Capital is the capital available for daily operations and is calculated as current assets minus current liabilities.
Note: The formula chosen should be consistently applied (do not switch between formulas when conducting trend analysis or peer comparisons) as the calculation differs depending on which formula is used. Generally, total assets minus current liabilities is the most commonly used formula.
Sample Calculation
Mary is looking to calculate the capital employed of ABC Company, compiling the following information:
Using the first formula above, Mary calculates the amount as follows:
Capital Employed = $100,000 + $350,000 – $50,000 = $400,000
Interpreting Capital Usage
This metric provides an insight into how well a company is investing its money to generate profits. Although the figure varies depending on the formula used, the underlying idea remains the same.
The number in itself is seldom used by analysts. It is commonly used in conjunction with earnings before interest and tax (EBIT) in the return on capital employed (ROCE) ratio. As will be explained below, ROCE is a commonly used ratio by analysts for assessing the profitability of a company for the amount of capital used.
Return on Capital Employed
Return on capital employed (ROCE) is a profitability ratio that measures the profitability of a company and the efficiency with which a company is using its capital. The ROCE is considered one of the best profitability ratios, as it shows the operating income generated per dollar of invested capital. The formula for ROCE is as follows:
ROCE = Earnings Before Interest and Tax (EBIT) / Capital Employed
Example of ROCE
Recall that the capital employed for ABC Company in our example above is $400,000. Assuming that earnings before interest and taxes figure of ABC Company is $30,000, what is the ROCE?
ROCE = $30,000 / $400,000 = 0.075 = 7.5%
For every dollar of invested capital, ABC Company generated 7.5 cents in operating income.
Related Readings
Thank you for reading CFI’s guide to Capital Employed. To keep learning and advancing your career, the following CFI resources will be helpful:
FAQs
Return on capital employed is a financial ratio that measures a company's profitability in terms of all of its capital. ROCE is similar to return on invested capital. It's always a good idea to compare the ROCE of companies in the same industry because those from differing industries usually vary.
What is your capital employed? ›
Simply put, capital employed is the total amount of funds that are deployed to run the business in order to generate profit. The figure commonly used to calculate capital employed is: Total assets – current liabilities = Equity + Noncurrent liabilities.
How do you answer working capital? ›
The working capital calculation is:
- Working Capital = Current Assets - Current Liabilities.
- Working Capital Ratio = Current Assets / Current Liabilities.
- Inventory Days + Receivable Days - Payable Days = Working Capital Cycle in Days.
- Net Working Capital = Current Assets (Minus Cash) - Current Liabilities (Minus Debt)
Whether a business has enough working capital is measured by the 'current ratio', or current assets divided by current liabilities. Generally, a current ratio of between 1.2 and 2 is considered the sign of a healthy business.
How to find capital employed formula? ›
What is the formula to calculate capital employed? The most commonly used formula to calculate capital employed is as follows: Capital employed = total assets – current liabilities.
How to interpret return on capital employed? ›
The return on capital employed (ROCE) metric answers the question of, “How much in profits does the company generate for each dollar in capital employed?” Given a ROCE of 10%, the interpretation is that the company generates $1.00 of profits for each $10.00 in capital employed.
What is an example of capital employment? ›
Assume that a company had $50,000 capital employed. This could be broken down by capital used for the business (working capital) and capital used for investment (buying new equipment). If they had $10,000 in working capital and $40,000 that was used to buy land then their capital employed would be $50,000.
What is normal capital employed? ›
The Capital Employed Formula
- There are two common ways to calculate capital employed: the subtraction method and the addition method.
- Subtraction Method.
- capital employed = total assets - current liabilities.
- capital employed = fixed assets + working capital.
Compute Taxable Capital: Utilize the following formula to calculate taxable capital: Taxable Capital = (Shareholders' Equity – Non-deductible Items) + Liabilities.
What is the capital answer in one sentence? ›
The total amount invested in the business by the owner is called Capital. Excess of assets over the liabilities is known as Capital.
Working capital is referred to as the capital that is essential for running the day to day operations of a business. Therefore, it is the difference between current liabilities and current assets.
How do I calculate my working capital? ›
Working Capital Formula & Ratio: How to Calculate Working Capital
- Working Capital = Current Assets - Current Liabilities.
- Net working capital = current assets (minus cash) - current liabilities (minus debt)
- Net working capital = accounts receivable + inventory - accounts payable.
Generally, a working capital ratio of less than one is taken as indicative of potential future liquidity problems, while a ratio of 1.5 to two is interpreted as indicating a company is on the solid financial ground in terms of liquidity. An increasingly higher ratio above two is not necessarily considered to be better.
What is a working capital example? ›
Working capital is calculated by taking a company's current assets and deducting current liabilities. For instance, if a company has current assets of $100,000 and current liabilities of $80,000, then its working capital would be $20,000.
What is poor working capital? ›
In most cases, low working capital means that the business is just scraping by and barely has enough capital to cover its short-term expenses. Sometimes, however, a business with a solid operating model that knows exactly how much money it needs to run smoothly still may have low working capital.
What is the return on total capital employed? ›
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.
What is the formula for return on working capital employed? ›
Return on capital employed is determined by dividing net operating profit, also known as earnings before interest and taxes (EBIT), by the amount of capital employed. Another method is to divide profits before interest and taxes by the difference between total assets and current liabilities.
Is return on capital employed the same as ROI? ›
Both measures are similar in theory, however, ROCE looks at how capital is employed within a firm and is useful when comparing companies within an industry. ROI looks purely at the profit made on an investment.
What is the formula for ROE and ROCE? ›
Return on equity (ROE) is a commonly used metric for comparing companies. It's relatively straightforward and is calculated by dividing the net income by total equity. On the other hand, return on capital employed (ROCE) is calculated by dividing the operating profit after taxes by the capital employed.
