Understand what capital employed really means, how to calculate it, and how to use ROCE to measure efficiency and make smarter business decisions.
0
min read
Metrics like profit and turnover will always be the bread and butter of measuring business performance. Indeed, they’re a good shorthand for a quick pulse check on your company’s financial health. But to truly understand how your business is performing, you’ll need to dig a bit deeper. One of the key metrics that’ll give you a clearer picture of financial health and efficiency is capital employed.
In this guide, we’ll break down what capital employed means in practice, how to calculate it, and how to use it to make better business decisions.
Capital employed refers to the total amount of capital used to run your business. In simple terms, it’s your total assets minus current liabilities. It shows how much is being invested in the business to generate profits (including both equity and long-term debt).
This measure is especially useful for understanding how efficiently your company is using its capital. Whether you’re looking to attract investors, secure funding, or simply evaluate performance, understanding what capital employed means is essential.
You’ll often see this metric used alongside profitability ratios, particularly return on capital employed (ROCE), which we'll cover in detail below.
Not quite. The numbers can be similar, but they aren't always interchangeable. Capital employed typically includes long-term liabilities, while net assets may not. It's worth checking the specific context and calculation method being used.
The basic formula for capital employed is:
Capital Employed = Total assets – current liabilities
Let’s break this down:
Example:
Let’s say your balance sheet shows:
Then your capital employed calculation would be: £500,000 – £120,000 = £380,000
This indicates how much capital is actively being utilised in your operations. Knowing how to calculate capital employed lets you delve deeper into performance analysis.
The most common method is to subtract current liabilities from your total assets, but some versions may also factor in fixed assets plus working capital. Always check what definition your accounting platform or reporting standard uses.
Return on capital employed (ROCE) indicates how efficiently your business is turning capital into profit. It's one of the most valuable ratios for financial analysis because it connects investment with output.
In other words, ROCE tells you how much profit you’re generating for every penny you’ve invested in the business. It’s handy for comparing your performance over time or benchmarking against similar companies in your industry.
The higher your ROCE is, the better you’re using your available capital (generally speaking).
The return on capital employed ratio formula is:
ROCE = (Operating profit/Capital employed) × 100
Let’s go back to our earlier example. You’ve calculated capital employed as £380,000. If your operating profit is £76,000, then:
ROCE = (£76,000/£380,000) × 100 = 20%
That means for every £1 you’ve employed in the business, you’re generating 20p in operating profit.
This is a useful way to compare how your business performs across financial periods or against your competitors. Knowing how to calculate return on capital employed helps you focus on both profitability and capital efficiency.
Capital employed is broader than just equity. Capital employed represents the total long-term funds used in the business – a combination of both the owners' investment and any long-term financing, such as debt.
In contrast, equity refers strictly to the shareholders' claim on the business, including initial capital contributions and accumulated retained earnings.
The components of capital employed usually include:
Equity represents the owners’ interest in the business, while capital employed reflects all the long-term funding sources (including borrowed money).
Understanding this difference is important when analysing financial statements. You may be profitable, but if your capital base is bloated with unused assets or excessive debt, your ROCE could still be weak.
Taking on a loan inevitably increases your capital employed. This is since it usually raises your total assets (through cash received) and/or your long-term liabilities. That means your capital base grows.
This can have both positive and negative effects on ROCE. If the loan is used to grow profits (for example, by buying equipment or hiring people that boost output), then your ROCE might improve. But if the added capital doesn’t lead to higher operating profits, your ROCE could fall.
The key is to use borrowed funds strategically. Whether it's to expand operations, invest in tech, or manage cash flow, ensure it improves how you use capital (not just increases the amount of it).
It increases it by boosting either your assets or your liabilities, or both. This has a direct impact on your ROCE, which is why you should always factor in the efficiency of how that capital is used.
What counts as a ‘good’ ROCE varies by industry. Some sectors are naturally more capital-intensive (like manufacturing), while others (like software) can achieve high returns with less investment.
As a general guide, anything above 15% is considered healthy, though it’s better to benchmark against your peers.
To improve your ROCE, focus on:
Monitoring ROCE regularly can help you spot inefficiencies early and take action before they affect your bottom line.
Working capital is a short-term measure. It’s calculated as:
Working Capital = Current assets – current liabilities
It tells you about your day-to-day liquidity – in other words, whether you can cover your short-term obligations.
Capital employed, on the other hand, looks at your long-term position. It shows how much capital is invested in running and growing the business.
Both are important. Working capital helps you manage cash flow. Capital employed helps you assess overall efficiency and profitability. Understanding how and when to use each metric gives you a clearer financial picture.
If you’re looking to boost performance or invest in new opportunities, a Flexi-Loan from iwoca could be the tool you need. Whether you want to grow your team, purchase new equipment or smooth out cash flow, a Flexi-Loan is an unsecured loan that gives you the flexibility to borrow what you need, when you need it.
You only pay interest on the amount you borrow, and you can repay early at no extra cost. That means you stay in control of your capital, and you can use it where it delivers the most value.
An iwoca’s Flexi-Loan can support your business growth plans, whether that’s new equipment, hiring or covering a cash shortfall. Apply today.
