What is Capital Employed?

Capital employed is a financial measure that is used to measure the total funds that a company has employed in its business to generate profits, which include both equity and debt. It is a measurement of the true financial resources available to the company, which includes the fixed assets of the company as well as its working capital.

The common formula for calculating capital employed is:

Where, 

Total assets are everything the company owns, from cash and inventory to equipment.

Current Liabilities are the short-term obligations due within a year, such as accounts payable and short-term debt.

It can also be calculated as:

The capital employed measure becomes especially useful for ROCE, which looks at how the operating profit of the firm is compared to the capital invested in it. The firm with high operating profits compared to the capital invested is considered more efficient with its use of resources.

To sum up, the capital employed measure reveals how much capital a firm uses in its operations.

What is the Importance of Capital Employed?

• Capital employed helps to evaluate the use of resources: It indicates the amount invested by the business into its activities, and hence tells whether the growth is driven by the reinvestment of funds or whether it is being hindered by underutilization of available resources.
• It allows benchmarking: Capital employed compared to other businesses of the same industry helps to understand which businesses are expanding their resource base more effectively in relation to their size.
• The metric serves directly for profitability evaluation: Capital employed serves as the basis for one of the most important ratios, Return on Capital Employed (ROCE).
• The information is used for decision-making: Management and investors use the metric to assess whether the business is utilizing its capital effectively or is simply increasing its asset base without the corresponding increase in returns.
• Should be compared to returns: An increasing capital employed may only mean good things if returns are growing proportionally; otherwise, it is rather a sign of inefficiency than growth.

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