Definition
Capital employed refers to the total amount of funds invested in a business, which is essential for generating profits. It represents the value of assets used by a company to produce goods or deliver services, including equity and debt. The calculation for capital employed typically involves summing the shareholders’ equity and debt liabilities, or deducting current liabilities from a company’s total assets.
Phonetic
Capital Employed: /ˈkæpɪtl ɛmˈplɔɪd/
Key Takeaways
- Capital Employed represents the total amount of capital invested in a business: Capital Employed is a measure of the total resources used by a company to generate profit. It includes both shareholders’ equity and long-term liabilities, which are used to finance the company’s assets like property, plant, and equipment. Understanding Capital Employed provides insight into a company’s financial performance and offers a basis for comparing similar businesses.
- It is an important metric for evaluating a company’s profitability and efficiency: Capital Employed can be used to calculate return on capital employed (ROCE), a key financial ratio that indicates a company’s efficiency at generating profits from its capital. A higher ROCE indicates that the company is using its capital more effectively, leading to greater profitability and potential growth. Thus, investors and analysts often use ROCE as an indicator of management’s effectiveness and the company’s potential for generating shareholder value.
- Capital Employed can be calculated in multiple ways: There are different ways to calculate Capital Employed, but the two most common methods are: (1) Total Assets minus Current Liabilities, and (2) Shareholders’ Equity plus Long-term Debt. It is important to note that different calculations can result in different Capital Employed figures, so when comparing companies or evaluating financial performance, it is crucial to use the same calculation method consistently.
Importance
Capital Employed is an important business/finance term because it serves as a key indicator of a company’s operational efficiency and overall financial performance. By measuring the total amount of financial resources a company has allocated to generating revenue and profit, it enables stakeholders, such as investors and management, to assess the effectiveness of resource allocation and utilization. It helps in determining return on investment, debt levels, and potential for growth. Moreover, it enables comparisons between similar businesses, thus providing valuable insights for decision-making and strategic planning that can enhance organizational competitiveness and sustainability.
Explanation
Capital employed serves as an essential tool for assessing a company’s utilization of resources and profitability. Primarily, it measures the amount of funds invested to generate revenue from a business’s primary operations. In simpler terms, capital employed can be viewed as the financial value of a company’s assets, minus any liabilities or debts. By analyzing this metric, investors and business owners gain valuable insight into how effectively a company allocates its capital to generate income and grow over time. The purpose of evaluating capital employed is multifold, with one major aim being to determine a company’s financial performance. Comparing this metric across different companies within the same industry allows investors to identify potential investment opportunities, as businesses with a lower capital employed ratio may signal underutilized resources and potential growth. In addition, tracking changes in capital employed can help uncover trends that might suggest a company is either expanding or divesting. Furthermore, coupling this metric with other financial ratios like return on capital employed (ROCE) offers a comprehensive understanding of a company’s efficiency, enabling shareholders and management to make informed decisions about investing, asset allocation, and corporate strategy.
Examples
1. Apple Inc.: In Apple Inc.’s FY 2020, the company had total assets of $354.1 billion and current liabilities of $108.1 billion. By calculating the Capital Employed, we subtract current liabilities from total assets: $354.1 billion – $108.1 billion = $246 billion. Apple’s Capital Employed shows the valuable resources used in the company by equity holders and debtors for the year 2020. 2. Amazon: In Amazon Inc.’s FY 2020, the company had total assets of $321.2 billion and current liabilities of $115.8 billion. By calculating the Capital Employed, we subtract current liabilities from total assets: $321.2 billion – $115.8 billion = $205.4 billion. The Capital Employed indicates the amount of resources from equity and debt financing that Amazon utilized for its operations in 2020. 3. McDonald’s Corporation: In McDonald’s FY 2020, the company had total assets of $53.3 billion and current liabilities of $6.2 billion. To calculate the Capital Employed, we subtract current liabilities from total assets: $53.3 billion – $6.2 billion = $47.1 billion. McDonald’s Capital Employed signifies the resources invested by equity holders and debtors in the company for 2020.
Frequently Asked Questions(FAQ)
What is Capital Employed?
How do you calculate Capital Employed?
Why is Capital Employed important in finance and business?
How does Capital Employed differ from Capital Expenditure?
What is the relationship between Capital Employed and Return on Capital Employed (ROCE)?
Can Capital Employed be negative?
How can a company improve its Capital Employed?
Related Finance Terms
- Return on Capital Employed (ROCE)
- Working Capital
- Fixed Assets
- Net Operating Profit
- Capital Expenditure
Sources for More Information
