How to calculate capital employed for your business

To calculate capital employed, take your total assets and subtract your current liabilities. In other words, add up everything your business owns, then take away everything it needs to pay within the next 12 months. You'll find both figures on your balance sheet. Capital employed shows how much money is tied up in running your business over the long term, whether it came from you, your shareholders or a lender. The number becomes really useful when you compare it with your profit, because that shows how hard your money is working for you.

This guide covers what capital employed means, the two ways to calculate it, a full worked example, how to use it to work out your return on capital employed (ROCE), how it differs from working capital and net assets, and simple ways to improve your figures.

What is capital employed?

Capital employed is the total long term funding your business uses to trade and generate a profit. It's made up of three things:

• The money you and any other owners have put into the business.

• The profits you've kept in the business rather than taken out, known as retained earnings.

• Any borrowing you don't have to pay back in the next 12 months, such as a long term business loan.

You can also think of it as everything your business owns, minus the bills and debts you need to pay soon. What's left is the money that's in your business for the long haul, paying for things like your premises, equipment, vehicles, stock and the cash you need day to day. Because it covers all of your long term money, capital employed lets you see how well your business turns that money into profit.

What is the formula for capital employed?

There are two ways to calculate capital employed. One looks at what your business owns, and the other looks at where your money came from. The first method starts with what you own:

Capital employed = total assets minus current liabilities

The second method starts with where the money came from:

Capital employed = shareholders' equity plus non current liabilities

Both give the same answer because a balance sheet always balances. What your business owns is always equal to what the owners have put in plus everything the business owes. If your two answers don't match, a figure has usually been missed or put in the wrong place.

What goes into the capital employed calculation?

Your balance sheet splits everything into a few groups. Your accountant or accounting software will usually do this for you, but it helps to know what each one means. Assets are the things your business owns. They come in two types:

• Fixed assets, also called non current assets, are things you plan to keep for more than a year, such as property, machinery, vehicles and computers. They can also include intangible assets, such as goodwill, which is the value of things like your brand and customer relationships.

• Current assets are things that will turn into cash within a year, such as stock, money customers owe you and the cash in your bank account.

Liabilities are the things your business owes. They also come in two types:

• Current liabilities are bills and debts you need to pay within 12 months, such as supplier invoices, value added tax (VAT), corporation tax, wages, your overdraft and this year's loan repayments.

• Non current liabilities are debts you pay back after 12 months, such as the rest of a long term business loan, hire purchase agreements and long term leases.

Shareholders' equity is the part of the business that belongs to its owners. It's made up of share capital, which is the money owners paid for their shares, plus the retained earnings kept in the business since it started. If you're a sole trader or in a partnership, you'll see this as your capital account instead.

How do you calculate capital employed step by step?

Calculating capital employed only takes a few minutes once you have an up to date balance sheet.

1. Find your latest balance sheet, either from your last annual accounts or by running one in your accounting software.

2. Add up your total assets, including both fixed assets and current assets.

3. Add up your current liabilities, meaning everything you need to pay within the next 12 months.

4. Take your current liabilities away from your total assets. The answer is your capital employed.

5. Check your answer by adding your shareholders' equity to your non current liabilities. You should get the same figure.

If you run a limited company, your accounts on Companies House include a balance sheet, so you can work out capital employed for past years too. Doing the sum for two or three years in a row shows whether the money in your business is growing and whether your profit is keeping up.

What does a worked example of capital employed look like?

Here's an example for a small manufacturing business, using the figures from its balance sheet at the end of the year.

Using the first method, the business owns £550,000 of assets and has £100,000 to pay within the year. £550,000 minus £100,000 gives capital employed of £450,000. Using the second method, the owners' share is £300,000 and the long term debts are £150,000. Adding them together also gives £450,000, so the figure is right. That means this business has £450,000 of long term capital working for it. £300,000 of that comes from the owners and £150,000 from long term borrowing.

How do you use capital employed to work out ROCE?

The main reason to work out capital employed is to calculate your return on capital employed, or ROCE. It shows how much profit your business makes for every pound of long term money it uses.

ROCE = (operating profit ÷ capital employed) × 100

Operating profit is the profit you make from trading, before interest and tax are taken off. You'll also see it called earnings before interest and tax (EBIT). You use this figure, rather than net profit, because capital employed includes borrowed money, so you need to look at your profit before any interest is paid to lenders. In our example, the business made an operating profit of £90,000 for the year. £90,000 divided by £450,000, multiplied by 100, gives a ROCE of 20%. Put simply, every £1 of capital in the business generated 20p of operating profit. If your capital employed changed a lot during the year, for example after buying a big piece of equipment, you can use the average across the year instead. If the business started the year at £410,000 and ended at £450,000, the average is £430,000. £90,000 divided by £430,000 gives a ROCE of about 20.9%.

What is a good return on capital employed?

A good ROCE is one that's higher than the cost of the money you're using. For example, if your business borrows at 9% interest but makes a ROCE of 20%, every pound you borrow earns more than it costs. If your ROCE is lower than what you pay to borrow, that money is costing you more than it's bringing in. There isn't one target that suits every business. If your business needs a lot of property, machinery or vehicles to trade, you'll have more capital employed, so you'll need more profit to reach the same ROCE as a business that needs very few assets. That's why the most useful comparisons are:

• Your own ROCE over several years, so you can see whether you're getting better or worse at using your money.

• Your ROCE against the cost of borrowing, so you know whether new funding is likely to pay for itself.

• Your ROCE against similar businesses in your sector, using the accounts of larger companies, since many small companies don't publish their profit and loss account.

A rising ROCE is usually a good sign. A falling ROCE isn't always bad news either. It can simply mean you've recently bought new equipment or premises that haven't had time to boost your profit yet.

How is capital employed different from working capital and net assets?

Capital employed, working capital and net assets all come from your balance sheet, so they're easy to mix up. Each one tells you something different about your business.

The main difference between capital employed and net assets is long term borrowing. Net assets only counts the owners' share. Capital employed also includes money you've borrowed long term, which is why it's the better way to see how well all of your money is being used. Working capital is a shorter term measure of liquidity, which means how easily your business can cover its day to day bills. .

What can make your capital employed figure misleading?

Capital employed is a simple sum, but a few things can make the figure look better or worse than it really is.

• Older assets that have been depreciated over many years, meaning their value on your balance sheet has been reduced each year, can make your capital employed look low and your ROCE look better than it really is.

• Property recorded at what you paid for it, rather than what it's worth today, can hide how much money is really tied up in your business.

• A lot of cash in the bank adds to your capital employed even though it isn't earning much, which can pull your ROCE down.

• An overdraft you use all year round counts as a current liability, so it's left out of capital employed even though it's really working like long term funding.

• A big purchase just before your year end can make capital employed jump, which is why using an average across the year can give a fairer result.

Capital employed also doesn't show how much cash is coming in and going out. A business with a strong ROCE can still run short of cash if customers pay late, so it's worth looking at it alongside your cash flow statement.

How can you improve your return on capital employed?

There are two ways to improve your ROCE. You can make more profit, or you can make the same profit using less money. The best plans usually do a bit of both.

• Reviewing your pricing and profit margins can increase your operating profit without needing any extra capital.

• Selling equipment or vehicles you rarely use frees up capital that isn't earning anything for your business.

• Keeping less stock, closer to what you actually sell, stops cash sitting on your shelves.

• Chasing customers to pay sooner means less money is tied up in unpaid invoices.

• Spreading the cost of new machinery or vehicles with asset finance lets the equipment start earning straight away, without using up your cash to buy it outright.

• Buying equipment that clearly increases what you can produce, or cuts your costs, makes sure the new money pays for itself.

The goal isn't always to keep capital employed as low as possible. Sometimes the right move is to invest more, as long as the extra profit is more than the cost of the funding.

Why do lenders look at capital employed?

Capital employed and ROCE show how well your business uses the money it already has. A ROCE that's comfortably higher than the cost of borrowing shows your business turns investment into profit, and that profit is what you'd use to pay back any new loan. It's also worth looking at where your capital employed comes from. The split between the owners' money and long term borrowing shows how much of your business is funded by debt. The more you've borrowed, the more of your profit goes on interest and repayments. If you're thinking about borrowing to grow, work out your capital employed and ROCE before you apply. It helps you show a lender what the money is for and how it will pay for itself. At Capitalise, we work with a panel of 130+ lenders, so you can compare business loans that suit your plans in one place.

Put your capital to work with a business loan

If your ROCE shows your business makes more from its money than it would cost to borrow, a business loan could help you invest in the equipment, premises or growth plans that increase your profit. Tell us how much you need and what it's for, and a dedicated funding specialist will help you put together a strong application and send it to the most suitable lenders from our panel.