How to Calculate Capital Employed From a Company's Balance Sheet (2024)

A company's balance sheet offers a snapshot of how a company utilizes its capital resources at a given point in time. To perform a capital-employed analysis, focus on funds being used during the operating cycle and the origin of those funds. The most important items to identify on a balance sheet when performing a capital-employed analysis are fixed assets, inventories, trade receivables, and payables.

Capital Investments

A capital-employed analysis provides useful information about how management invests a company's money. However, it can be problematic to define capital employed because there are so many contexts in which it can exist. However, most definitions generally refer to the capital investment necessary for a business to function.

Capital investments include stocks and long-term liabilities, but they can also refer to the value of assets used in the operation of a business. Put simply, capital employed is a measure of the value of assets minuscurrent liabilities. Both of these measures can be found on a company's balance sheet. A current liability is the portion of a company's debt that must be paid back within one year. In this way, capital employed is a more accurate estimate of total assets.

Return on Capital Employed (ROCE)

Capital employed is better interpreted by combining it with other information to form an analysis metric such asreturn on capital employed (ROCE). Likereturn on assets(ROA), investors use ROCE to get an approximate estimate of what their return might be in the future. Return on capital employed (ROCE) is thought of as a profitability ratio. It compares netoperating profitto capital employed and informs investors how much each dollar of earnings is generated with each dollar of capital employed.

A company finances its capital employed through its capital investments. Pay attention to shareholders' equity, net debt, and other long-term assets and liabilities when performing an analysis. These items provide a sense of future capital flexibility.

Capital Employed Analysis

As mentioned earlier, capital employed is a catch-all phrase. No fixed or universal definitions explain what capital employed means—or, rather, different definitions are based on different contexts. The simplest presentation of capital employed is total assets minus current liabilities. Sometimes it is equal to all current equity plus interest-generating loans (non-current liabilities).

Fundamental investors most frequently refer to capital employed as part of the return on capital employed (ROCE) or return on average capital employed (ROACE) metrics. ROCE and ROACE compare the company's profitability to the total investments made in new capital.

Some consider capital employed as long-term liabilities plus share capital plus profit and loss reserves. In this circ*mstance, net assets employed is always equal to capital employed.

Calculating Capital Employed: Fixed Asset Method

One of the simplest ways to determine capital employed is by reviewing a company's balance sheet. This method involves four steps:

Step 1: Locate the Net Value of All Fixed Assets

The non-current (or long-term) asset section of the balance sheet will include the company's fixed assets. The section is referred to as . With the exception of land, fixed assets will be reported with their depreciated value.

Step 2: Add Capital Investments

Add all capital investments that have come into the business. This can include any individual, financial institution, or venture capital funding or investments that have been made in the business.

Step 3: Add Current Assets

In the assets section of the balance sheet, items are listed in order of their liquidity. Items that can be more easily converted to cash are at the top of the list. The list will be divided into current assets and non-current or long-term assets.

Current assets can be converted to cash in one year or less, while long-term assets take longer to convert. While it's easiest to use the original cost, some companies prefer to use replacement cost after depreciation. Add to your calculation all current assets, including cash in hand, cash at banks, bills receivable, stock, and other current assets.

Step 4: Subtract Current Liabilities

Current liabilities are a company's short-term financial obligations, usually due within a year or less. You'll find current liabilities reported on the company's balance sheet. Examples include accounts payables, accrued expenses, short-term debt, and dividends payable.

Calculating Capital Employed: Other Methods

In certain contexts, it may be most appropriate to simply use the shareholder's equity method. Because shareholder's equity equals total assets less total liabilities, this may be the same as capital employed under the fixed asset method if a company does not have any long-term liabilities. For example, if there are no long-term liabilities, this means 100% of liabilities are current. This also means the calculation using the total assets method will equal the equity method. Note that there may be considerations on what the company has on its balance sheet for total assets as well.

Looking at the fixed asset method, one could deduce that a company is essentially including all assets. In certain contexts, this may not be the case. For a simplified formula, some companies may calculate capital deployed as total assets less current liabilities. This can be assumed if the company does not have many assets outside of current assets and fixed assets.

Last, companies can also back into capital employed if they do have long-term liabilities and know total shareholders' equity. Because the fixed asset method subtracts current liabilities, a company really only needs to add back the long-term liabilities to total equity to arrive at capital employed.

The Bottom Line

Capital employed represents the total amount of capital or funds invested in a business or project. It encompasses both long-term and short-term financing sources, including fixed assets, working capital, long-term liabilities, and shareholders' equity. Calculating capital employed provides insights into the scale and financial health of a company, its ability to generate returns, and the efficiency of capital utilization.