Definition of Capital Employed
The term “capital employed” refers to the total amount of funds used by a company for generating profit from its business. In other words, it is the dollar amount of all the company assets that are employed in a business. To put it simply, all business is run with the intent of earning profits and for that, it requires to employ some funds, which gives way to the concept of CE.
The primary use of CE is in the calculation of return on capital employed (ROCE) which basically compares the net operating profit generated by a business relative to the CE in the business.
Formula
The formula for CE can be derived by deducting total current liabilities from the total assets of the company. Mathematically, it is represented as,
Another implication of the above formula for CE is that it can also be expressed as the sum of shareholder’s equity and long term liabilities, which is mathematically represented as,
Another form of the formula involves calculation as the sum of long term assets and working capital, which is mathematically represented as,
Examples of Capital Employed (With Excel Template)
Let’s take an example to understand the calculation of CE in a better manner.
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Example #1
Let us take the example of a company to demonstrate the calculation. The following balance sheet information is available according to the annual report for the year 2018. Calculate the capital employed by the company for the year 2018 using all the three methods of calculation.
Solution: Formula
Method 1
CE is calculated using the formula given below
Capital Employed = Total Assets – Total Current Liabilities
- CE = $150.00 million – $42.50 million
- CE = $107.50 million
Method 2
CE is calculated using the formula given below
Capital Employed = Shareholder’s Equity + Long Term Liabilities
- CE = $37.85 million + $69.65 million
- CE = $107.50 million
Method 3
CE is calculated using the formula given below
Capital Employed = Total Current Assets – Total Current Liabilities
- CE= $60.25 million – $42.50 million
- CE = $17.75 million
Method 4
CE is calculated using the formula given below
Capital Employed = Long Term Assets + Working Capital
- CE = $89.75 million + ($60.25 million – $42.50 million)
- CE = $89.75 million + $17.75 million
- CE = $107.50 million
Therefore, the total CE by the company during the year 2018 was $107.50 million.
Example #2
Let us take the example of Apple Inc.’s financial position of 2018 to illustrate the concept of CE. As of September 29, 2018, the company reported total assets of $365.73 billion and total current liabilities of $116.87 billion. Calculate the total capital employed by Apple Inc. in 2018.
Solution:
CE is calculated using the formula given below
Capital Employed = Total Assets – Total Current Liabilities
- CE = $365.73 billion – $116.87 billion
- CE = $248.86 billion
Therefore, Apple Inc. employed a total capital of $248.86 billion during the year 2018.
Source Link: Apple Inc. Balance Sheet
Example #3
Let us take the example of Walmart Inc. also to illustrate the concept of CE. According to the annual report, the company reported total assets of $204.52 billion and total current liabilities of $78.52 billion as of January 31, 2018. Calculate the capital employed by Walmart Inc. during 2018.
Solution:
CE is calculated using the formula given below
Capital Employed = Total Assets – Total Current Liabilities
- CE = $204.52 billion – $78.52 billion
- CE = $126.00 billion
Therefore, Walmart Inc. employed a total capital of $126.00 billion during the year 2018.
Source Link: Walmart Inc. Balance Sheet
Advantages of CE
Some of the advantages are:
- The metric gives a fair idea about how a company is investing the funds to produce profits.
- It is primarily used in the calculation of ROCE, which is predominantly used by investors to measure the financial performance of companies.
Limitations of CE
Some of the limitations are:
- The value of CE can be manipulated by classifying some of the long term liabilities as current liabilities or long term assets as current assets.
- There is no clarity about whether to use book value or replacement value of assets, both are practices are in vogue.
- The metric has limited application in the context of financial analysis.
Conclusion
So, it can be concluded that capital employed gives insight into the capital structure of a company i.e. the sources of the funds needed for running the business operation. But it is primarily used in conjunction with operating profit in the calculation of ROCE and has limited use otherwise. However, please note that the metric is exposed to risk accounting manipulation.
Recommended Articles
This is a guide to Capital Employed. Here we discuss how to calculate CE along with practical examples, advantages, and limitations. we also provide a downloadable excel template. you may also look at the following articles to learn more –
