Capital Employed
Candlefocus EditorAn entity’s capital employed can be either debt (loans, overdrafts, etc.) or equity (shares, retained profits, etc.). Depending on the type of capital employed, the returns associated with it will vary accordingly. If a company is funded mainly with debt, the repayment obligations to creditors will reduce the available funds for operations and growth investment; whereas if a company is mostly funded with equity, the associated returns are linked to ownership and will be managed by the owners rather than to the creditors – both of which need to be taken into account when considering the return on capital employed.
With the amount of capital employed, businesses can analyse the performance of their investments in terms of return. Return on capital employed (ROCE) is a popular financial analysis metric used to measure the effectiveness of an investment. It is calculated by dividing the net income of an organisation by its total capital employed, arriving at an expression of the percentage of return for each dollar invested. As such, it is important to analyse ROCE when considering if the investment is a sound one for the business.
In short, the capital employed of a business is an important consideration when gauging the profitability of an investment. By subtracting total liabilities from total assets and by considering the type of capital employed, businesses can analyse the return on investment in terms of return it provides. By assessing the return on capital employed, businesses can evaluate the worthwhile and measure the performance of each investment.