Capital employed, also known as funds employed, is the total amount of capital utilized by a firm or project to generate profits. It can also refer to the value of all assets used by a company to generate earnings.
Why Understanding Capital Employed is Crucial
By employing capital, companies invest in the long-term future of the company. Understanding capital employed is beneficial as it aids in determining the return on a company’s assets and assessing the efficiency of management in utilizing capital.
Key Highlights:
- Capital employed can be calculated by subtracting current liabilities from total assets; or alternatively by adding noncurrent liabilities to owners’ equity.
- This metric helps you understand how much capital has been effectively put to use in an investment.
- Return on capital employed (ROCE) is a widely used financial analysis metric to determine the return on an investment.
Formula and Calculation of Capital Employed
@ Capital Employed = Total Assets - Current Liabilities@
Capital employed is determined by taking total assets from the balance sheet and subtracting current liabilities, which are short-term financial obligations.
Alternatively, it can be calculated by adding fixed assets to working capital, or by summing up equity and non-current liabilities (long-term liabilities).
How Capital Employed Eases Strategic Decision-Making
Capital employed gives a snapshot of how a company is investing its resources. All definitions generally refer to the capital investment necessary for a business to function.
Capital investments include stocks and long-term liabilities, as well as the value of assets used in the operation of a business. Essentially, it is a measure of the value of assets minus current liabilities.
Analyzing Efficiency with Return on Capital Employed (ROCE)
Capital employed is frequently used by analysts to determine ROCE. By comparing net operating profit to capital employed, investors gain insights into profitability.
Many analysts favor return on capital employed over return on equity (ROE) and return on assets (ROA) since it considers long-term financing and better gauges long-term profitability.
Calculation:
@ROCE = EBIT / Employed Capital@
A company’s ROCE can be assessed over time. A downward trend indicates declining profitability, while an upward trend indicates improving profitability.
Real-World Comparisons to Deep Dive Analysis
Let’s consider a comparison of return on capital employed by three tech giants: Alphabet Inc., Apple Inc., and Microsoft Corporation for the fiscal year ending 2021.
| $(in millions)$ | Alphabet | Apple | Microsoft |
|---|---|---|---|
| EBIT | $41,047 | $65,339 | $69,916 |
| Total Assets | $319,616 | $323,888 | $333,779 |
| Current Liabilities | $56,834 | $105,392 | $88,657 |
| ROCE | 0.1562 | 0.2990 | 0.2852 |
In this example, Apple Inc. emerges with the highest ROCE of 29.9%, implying the most efficient use of capital amongst peers.
Finding a Good ROCE
In essence, a higher ROCE is generally favorable, indicating that a company uses its capital more efficiently to generate profits.
Diving Deeper: Return on Average Capital Employed (ROACE)
ROACE measures profitability relative to investments over time. It differs from ROCE by using average assets and liabilities figures.
How to Extract Capital Employed from a Balance Sheet
- Identify the net value of all fixed assets listed as property, plant, and equipment (PP&E).
- Sum this value with capital investments and current assets.
- Subtract current financial obligations, usually under current liabilities like accounts payable, short-term debt, etc.
Conclusion: The Bottom Line on Capital Employed
Capital employed is the total amount of capital a company uses to generate profits. This concept incorporates all assets and long-term financing, providing a fuller picture of organizational efficiency. Understanding capital employed not only helps calculate ROCE but also enables better strategic business decision-making for sustained growth and profitability.
Related Terms: Return on Capital Employed (ROCE), Return on Assets (ROA), Current Liabilities, Fixed Assets.
References
- The Wall Street Journal. “MSFT - Financial Statements”.
- The Wall Street Journal. “GOOG - Financial Statements”.
- The Wall Street Journal. “AAPL - Financial Statements”.
