How to work out capital employed

51% of UK SMEs looked for external working capital finance in 2024. But many business owners still struggle to understand how efficiently they’re using their capital.

‘Capital employed’ is one of the most important financial metrics you can track. It shows how much money your business has invested in its operations and helps you measure how effectively you’re generating profits from that investment.

Whether you’re preparing for investor meetings, comparing your performance to competitors, or simply trying to understand your business better, knowing how to calculate capital employed is very important.

In this article, we’ll explain what capital employed is, how to calculate it, how to use it to benefit your business and more.

Key points:

• Capital employed measures the total amount of capital your business uses to operate

• You can use it to calculate return on capital employed (ROCE), which helps you track performance over time and compare performance against your industry peers

• Funding Options by Tide can help when optimisation of working capital isn’t enough, offering access to business finance up to £20 million

What is capital employed?

Capital employed tells you how much money your business has invested in its operations. It helps you understand the total amount of capital that’s actually working in your business to generate profits.

It’s different from simply looking at your total assets because it removes short-term liabilities that you’ll need to pay back within a year. This gives you a clearer picture of the long-term capital that’s genuinely employed in running your business.

Understanding your capital employed helps you make more informed decisions about working capital finance and other funding options – a valuable skill when you consider that 69% of SMEs lacked awareness of finance options in 2024.

Capital employed also helps you understand how your business compares to other businesses in your industry, since each sector has different capital requirements and efficiency expectations.

How do you calculate capital employed?

There are two main ways to calculate capital employed, and both will give you the same result if your balance sheet is accurate. But it’s important to pick one method and stick with it for consistency.

Subtraction method

Capital employed = total assets - current liabilities

This is the most common way to calculate capital employed. You take everything your business owns (total assets) and subtract what you need to pay back within a year (current liabilities).

Your total assets include fixed assets like property, equipment, and vehicles, plus current assets like cash, inventory, and money owed to you by customers.

Your liabilities include debts due within 12 months, such as supplier invoices, short-term loans, tax bills, and overdrafts.

Addition method

Capital employed = shareholders’ equity + non-current liabilities  

With this method, you add your shareholders’ equity (the money invested by owners plus retained profits) to your long-term debts (non-current liabilities like long-term loans or mortgages).

Both the subtraction and addition methods work because working capital equals current assets minus current liabilities. So when you expand the formulas, you get the same result: fixed assets plus working capital.

Why do the methods sometimes give different results?

Sometimes you’ll get slightly different answers from each method. This can happen because of timing differences in how items are recorded on your balance sheet, or small errors in categorising assets and liabilities.

This is why it’s important to be consistent. Once you choose a method, use it every time you calculate capital employed. This will help you track trends accurately and compare your performance over different periods.

Bear in mind that your calculation might also be slightly affected by which accounting framework your business uses. Most UK SMEs use FRS 102 (Financial Reporting Standard), while listed companies are required to use IFRS for their consolidated accounts.

How do you use capital employed to measure performance?

Capital employed is particularly useful when you calculate your Return on Capital Employed (ROCE), which shows how much profit you generate for every pound of capital invested in your business.

ROCE = Net operating profit (EBIT) / capital employed * 100  

Net operating profit is your earnings before interest and tax (EBIT). You can find this by taking your revenue, subtracting your costs of goods sold and operating expenses, but before deducting interest payments or tax.

So, for example, if your business has a capital employed of £150,000 and a net operating profit of £30,000, your ROCE would be 20% (£30,000 / £150,000 * 100).

Generally, a ROCE above 15-20% is considered good, but this will vary by industry. In the US, the technology sector had the highest average ROCE at 26%, followed by pharmaceuticals (22%) and software (21%) in 2024.

More capital-intensive industries usually have a lower ROCE. For example, manufacturing might be happy with 15%, while utilities might accept 10% because of the huge infrastructure investments required.

How can you use ROCE to make business decisions?

ROCE helps you identify whether your business is generating worthwhile returns compared to other investment options.

For example, if your ROCE is consistently below what you could earn from lower-risk investments, you might want to try improving operational efficiency or consider other strategies.

You can also use ROCE to evaluate specific projects or investments. So before expanding into new markets or buying expensive equipment, you can calculate the expected ROCE to see if it’s likely to be worthwhile.

Also consider how ROCE connects to your cash flow management – a high ROCE might look good on paper, but if you're struggling with day-to-day cash flow, you might need to balance efficiency with liquidity.

How can you improve your capital employed efficiency?

To improve your capital employed efficiency, you’ll need to get more profit from the same amount of invested capital (or maintain profits while using less capital).

Here are the main strategies you could try:

• Optimise your working capital: To free up cash while keeping your operations working smoothly, consider reducing inventory levels (within practical limits), speeding up customer payments, and negotiating longer payment terms with suppliers

• Improve asset utilisation: Make sure any expensive equipment and property are being used as much as possible. Consider shift patterns, equipment sharing, or rental during quiet periods

• Focus on higher-margin activities: Identify which of your products or services generate the best returns and prioritise these over those with lower-margins

• Reduce unnecessary assets: Sell equipment you don’t need, sublet unused space, or convert fixed costs to variable costs where possible

• Negotiate better supplier terms: Longer payment terms or bulk discounts can improve your working capital position without needing extra investment

• Speed up your sales cycle: The faster you can convert prospects to paying customers, the more efficiently you’ll use your sales and marketing investment

Given that asset finance reached a record £39.7 billion in 2024, with £23.5 billion specifically lent to SMEs, consider whether leasing equipment rather than buying it might free up capital for higher-return activities.

What are some common capital employed mistakes?

Even experienced finance managers can make mistakes when calculating capital employed. Here are the most common mistakes to avoid:

• Mixing up current and non-current items: Double-check that you’re correctly categorising assets and liabilities by their time frame. For example, an 18-month loan should be split between current (the portion due within 12 months) and non-current portions

• Using inconsistent calculation methods: Switching between the subtraction and addition methods makes it difficult to track trends accurately. So pick one method and stick with it

• Including personal assets in business calculations: This is particularly common with sole traders and small limited companies, where personal and business finances sometimes blur

• Timing issues with year-end calculations: Using figures from different dates or not accounting for seasonal variations can skew your results. So try to use figures from the same point in your business cycle

• Ignoring depreciation and asset valuations: Using original purchase prices rather than current book values can overstate your capital employed, making your ROCE appear lower than it actually is

• Not accounting for off-balance-sheet financing: Some lease arrangements or financing structures might not appear on your balance sheet but still represent capital employed in your business operations

• Forgetting to update calculations regularly: Capital employed should be monitored regularly. Monthly or quarterly updates will give you better insights into trends and performance compared to doing it yearly

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FAQs

What does my capital employed figure actually tell me about my business performance?

Capital employed shows how much long-term capital you’re using to run your business. When combined with your profit figures to calculate ROCE, it tells you how efficiently you’re generating returns from your investment. A higher ROCE generally indicates better performance and more efficient use of capital.

Am I calculating capital employed correctly, and how do I know if my result is good or bad?

You can use either ‘Total assets - current liabilities’, or ‘Shareholders’ equity + non-current liabilities’. Both should give the same result. Then compare your ROCE to industry benchmarks – above 15-20% is generally good, but it varies by sector. Technology companies can achieve over 25%, while utilities might be happy with around 10%.

Which calculation method should I use consistently?

Choose either the subtraction method (total assets - current liabilities) or the addition method (equity + non-current liabilities) and stick with it. Most UK SMEs use FRS 102, while listed companies use IFRS accounting standards. The accounting standard won’t change the calculation method but might affect how assets and liabilities are valued on your balance sheet.

Are there any UK regulatory requirements or best practices I need to consider when calculating and reporting capital employed?

There’s no specific requirement to calculate capital employed, but the underlying balance sheet figures will need to comply with UK accounting standards. So make sure your asset and liability classifications are accurate, stay consistent in your methods, and keep supporting documentation for any assumptions or adjustments.

What capital employed figures will investors expect to see?

Investors will typically look for improving ROCE trends and efficiency compared to your competitors. Startups often have lower initial ROCE due to upfront investments, but investors want to see a clear path to competitive returns.

How can I improve my capital efficiency to attract funding or demonstrate growth potential?

You can try optimising working capital by reducing inventory, speeding up collections, and improving supplier terms. Also consider maximising asset utilisation, focusing on higher-margin activities, and considering leasing rather than buying equipment. Investors will want to see a clear plan for improving ROCE as you scale.

At what stage should I start tracking capital employed, and how does it change as my business scales?

It’s a good idea to start tracking capital employed as soon as you have meaningful assets and want to measure efficiency. As you scale, capital employed typically increases but should be accompanied by proportional or better profit growth.

What’s the difference between capital employed and working capital?

Working capital is current assets minus current liabilities (i.e. the short-term funds available for day-to-day operations). Capital employed includes working capital plus fixed assets, representing the total long-term capital invested in your business.

How often should I calculate my capital employed?

Calculate capital employed monthly or quarterly to track trends and performance. Many businesses review it alongside other key metrics during monthly management accounts reviews. More frequent monitoring helps identify issues early and supports better decision-making.

Can capital employed be negative?

Yes, if your current liabilities exceed your total assets, capital employed would be negative. This could be a sign of financial difficulties and suggests your business might struggle to meet its financial obligations. So if this happens, seek professional financial advice immediately.

Do I need special software to calculate capital employed?

No, you can calculate it using figures from your existing accounting software or balance sheet. Most accounting packages like Xero, Sage, or QuickBooks should provide the figures you need. But some businesses use spreadsheets or financial analysis tools to track trends and create reports more easily.

How does capital employed relate to cash flow?

Capital employed shows the total capital invested in your business, while cash flow shows money moving in and out over time. You can have high capital employed but poor cash flow if your capital is tied up in slow-moving inventory or unpaid invoices.

Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

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