The Income|Outcome^® Contextuary

“What do you mean by that?”  

There are multiple definitions for Capital Employed, understanding which definition is being used is critical.   

A common financial analysis metric is Return on Capital Employed (ROCE):  

Ratio: Operating Income as a percentage of Capital Employed.    

Most definitions of ROCE use Operating Income or EBIT as the 'return', but the precise definition of Capital Employed can vary by company.  

Here are six possibilities:

1. Calculation: Capital Employed = Shareholders' Equity + Long-Term Debt

Example: The Round Number Company Operating Income = 30; Shareholder Equity = 140; Long-Term Debt = 100      Return on Capital Employed = 30/(140 + 100) = 30/240 = 12.5 %

      2. Calculation: Capital Employed =  Total Assets - Intangible Assets - Current Liabilities

Goodwill is also an Intangible so it is included in the calculation.

Operating Income = 30; Total Assets = 300; Intangibles = 8; Goodwill = 20; Current Liabilities = 36      Return on Capital Employed = 15/(300 - 8 - 20 - 36) = 30/236 = 12.7%

     3. Calculation: Capital Employed = Equity + Long-Term Liabilities 

Operating Income = 30; Shareholder Equity = 140; Long-Term Liabilities = 124      Return on Capital Employed = 30/(140 + 124) = 30/264 = 11.4 %

4. Calculation: Capital Employed = Total Assets - Current Liabilities. 

Operating Income = 30; Total Assets = 300; Current Liabilities = 36      Return on Capital Employed = 30/(300 - 36) = 30/264 = 11.4 %

     5. Calculation: Capital Employed = Fixed Assets + Working Capital.

where Working Capital = Total Current Assets - Total Current Liabilities

Operating Income = 30; Fixed Assets = 168; Current Assets = 132; Current Liabilities = 36      Working Capital = 132 - 36 = 96      Return on Capital Employed = 30/(168 + 96) =  30/264 = 11.4%

     6. Capital Employed = Total Assets - Current Liabilities - Cash and Cash Equivalents

Operating Income = 30; Total Assets = 300; Current Liabilities = 36; Cash = 20      Return on Capital Employed = 30/(300 - 36 - 20 ) =  30/244 = 12.3%

Definitions 3, 4, and 5 are different ways of expressing the same value.  An ROCE calculation using one of these definitions is equivalent to Return on Net Assets (RONA).