Capital Employed is a financial metric used to measure the total resources a company has invested in its operations. It provides insight into how effectively a company utilizes its assets and liabilities to generate returns. In this article, we will guide you through the process of calculating Capital Employed, highlight its importance, and give some advice on improving it.
How to calculate Capital Employed
The formula for calculating Capital Employed is quite simple and straightforward. It can be calculated using the following formula:
Capital Employed = Total Assets - Current Liabilities
Capital Employed calculation example
Consider a real-world example of a retail company, such as a clothing store. We'll use the following data to calculate the Capital Employed:
- Total Assets: $1,000,000
- Current Liabilities: $300,000
Now, just input the corresponding values into the equation.
Capital Employed = Total Assets - Current Liabilities
Capital Employed = $1,000,000 - $300,000
Capital Employed = $700,000
In this example, the Capital Employed for the clothing store is $700,000, which means the company has invested $700,000 in its operations, including assets and liabilities.
Why is Capital Employed important to understand?
Understanding Capital Employed is important for several reasons:
- Resource Utilization: Capital Employed helps assess how effectively a company uses its assets and liabilities to generate returns. A higher Capital Employed indicates that the company is investing more resources in its operations, which can signify growth and expansion. On the other hand, a lower Capital Employed may suggest that the company is not utilizing its resources efficiently, which could lead to stagnation or decline.
- Performance Benchmarking: Comparing Capital Employed across companies within the same industry can provide insights into their relative efficiency and performance. A company with a higher Capital Employed than its competitors may be better positioned to generate higher returns and grow its business. This comparison can help investors and business owners identify industry leaders and potential investment opportunities.
- Financial Health Assessment: Capital Employed, when used in conjunction with other financial metrics such as Return on Capital Employed (ROCE) and Return on Assets (ROA), can provide a comprehensive view of a company's financial health. A company with a high Capital Employed and strong ROCE and ROA ratios may be more financially stable and better positioned for long-term success. This information can be valuable for investors when making investment decisions and business owners when evaluating their company's performance and growth potential.
Strategies for improving Capital Employed
Here are some strategies that can help improve your Capital Employed:
- Optimize asset utilization: Regularly review and assess your company's assets to ensure they are used efficiently and effectively. This may involve selling underutilized assets, investing in more productive assets, or streamlining operations to reduce waste and improve efficiency. By optimizing asset utilization, you can increase your Capital Employed without increasing liabilities.
- Reduce current liabilities: Focus on reducing your company's current liabilities, such as accounts payable and short-term debt. This can be achieved by negotiating better payment terms with suppliers, consolidating debt, or improving cash flow management. By reducing current liabilities, you can increase your Capital Employed and strengthen your company's financial health.
- Invest in growth opportunities: Identify and invest in opportunities that have the potential to generate higher returns and grow your business. This may involve expanding into new markets, developing new products or services, or acquiring strategic assets. Investing in growth opportunities can increase your Capital Employed and position your company for long-term success.
