Definition of Employed Capital and Working Capital

Capital employed has many definitions and is not easily analyzed. In general, it represents the capital investment necessary for a business to function. Consequently, it is not a measure of assets, but of capital investment: stock or shares and long-term liabilities.


[edit] Definition
Capital employed is usually represented as total assets less current liabilities, or fixed assets plus working capital:

CapitalEmployed = FixedAssets + CurrentAssets − CurrentLiabilities
or
CapitalEmployed = FixedAssets + WorkingCapital

A further approach to assessing the stability of funding is to calculate the total long-term funds used by a company. Long-term debt, long-term liabilities, long-term provisions and equity provide obvious sources of long-term funding, but a further source is provided by the short-term debt that remains on the balance sheet at the year end. The sum of these sources of long-term funds is termed capital employed.


[edit] Use in financial analysis
Capital employed is used mostly for calculating return on capital employed (ROCE), an alternative to return on equity (ROE) and return on assets (ROA) ratios.


Working capital (also known as net working capital) is a financial metric which represents the amount of day-by-day operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities. A company can be endowed with assets and profitability, but short of liquidity, if these assets cannot readily be converted into cash.

Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact:

accounts receivable (current asset)
inventory (current assets), and
accounts payable (current liability)
In a situation where a company carries more cash than the mininum amount needed to maintain operations, the excess portion is usually excluded from working capital.

In addition, the current (payable within 12 months) portion of debt is critical, because it represents a short-term claim to current assets. Common types of short-term debt are bank loans and lines of credit.

A positive change in working capital indicates that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for example has paid off some short-term creditors.