What are 2 Ways to Calculate Capital Employed? - Formula and Calculation

What are 2 Ways to Calculate Capital Employed?

In the realm of financial analysis and business evaluation, understanding how to calculate capital employed is of utmost importance. Capital employed represents the total amount of capital invested in a business, and it serves as a key metric for assessing a company's financial health and operational efficiency. By accurately determining capital employed, businesses can gain valuable insights into their performance, make informed decisions, and drive long-term growth. In this article, we will explore two essential methods to calculate capital employed and shed light on their significance in financial analysis.

1. Capital Employed Calculation Method 1: Fixed Assets + Working Capital

The first approach to calculate capital employed involves considering both fixed assets and working capital. Fixed assets refer to the long-term assets owned by a company, such as property, plant, and equipment. Working capital, on the other hand, encompasses the current assets and liabilities required for day-to-day operations. To compute capital employed using this method, follow the formula:

Capital Employed = Fixed Assets + Working Capital

By summing up the value of fixed assets and working capital, businesses can obtain a comprehensive figure that represents the total capital employed in their operations. This method offers a holistic view of the resources invested in a company and is particularly useful for analyzing long-term investments and the operational efficiency of the business.

2. Capital Employed Calculation Method 2: Shareholders' Equity + Long-Term Debt

The second method for calculating capital employed focuses on the sources of financing used by a company. It considers shareholders' equity, which represents the owners' investment in the business, and long-term debt, which includes loans and other forms of borrowing that have a maturity exceeding one year. The formulation for this methodology can be expressed as follows:

Capital Employed = Shareholders' Equity + Long-Term Debt

This method emphasizes the capital structure of a company and provides insights into the financial obligations and commitments of the business. By including both equity and long-term debt, it offers a comprehensive view of the capital invested from the perspective of the company's stakeholders and lenders.

The Significance of Calculating Capital Employed

Accurately calculating capital employed is crucial for various financial analysis purposes, including:

1. Measuring Business Efficiency: 

Capital employed enables businesses to evaluate their effectiveness in utilizing resources to generate profits. By comparing capital employed to the company's revenue or profit figures, stakeholders can assess the efficiency of their investments and identify areas for improvement.

2. Assessing Return on Investment (ROI): 

Capital employed serves as a vital component in calculating ROI, a fundamental metric for evaluating the profitability of investments. By dividing the company's profit by the capital employed, businesses can determine the returns generated per unit of capital invested, helping them make informed decisions about future investments.

3. Facilitating Performance Benchmarking: 

Calculating capital employed allows businesses to compare their financial performance against industry peers and competitors. By understanding the capital employed figures of similar companies, businesses can identify areas where they may be over- or under-invested, and adjust their strategies accordingly to enhance their competitive edge.

4. Supporting Strategic Decision Making: 

Capital employed provides decision-makers with valuable information for strategic planning and resource allocation. By analyzing the composition of capital employed, businesses can identify potential risks, allocate resources effectively, and make informed decisions about future investments and expansions.

In conclusion, understanding how to calculate capital employed is vital for businesses seeking to optimize their financial performance and make informed strategic decisions. The two methods discussed above provide comprehensive insights into the resources invested in a company, offering a foundation for financial analysis and evaluation. By leveraging the knowledge gained from calculating capital employed, businesses can enhance their operational efficiency, attract investors, and drive long-term growth.