Capital employed and

invested capital

Marco Heimann

Principles for Responsible

Management Education

TOPICS

• The balance sheet

• The capital-employed analysis

• The liquidity-and-solvency analysis

THE BALANCE SHEET

Balance sheet = document in which all the assets of a

business and all of its financial
resources at a given point in time are
listed

Inflows/outflows = change in the balance outstanding

(“stock”)

Stock = arithmetic sum of inflows and outflows since a

given date through to a given point in time

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 THE BALANCE SHEET
Assets on the balance sheet comprise:

• Fixed assets
•
•
Inventories and trade receivables
Marketable securities and cash } current assets

Resources on the balance sheet comprise:

• Shareholders’ equity
• Liabilities

Assets = Resources

THE BALANCE SHEET

SHAREHOLDERS’ EQUITY
FIXED ASSETS

LIABILITIES
CURRENT ASSETS

Balance Sheet
 A snapshot in time of the firm’s financial position
 The Balance Sheet Identity:

Assets  Liabilities  Stockholders' Equity

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Balance Sheet (cont'd)
 Assets
> What the company owns

 Liabilities
> What the company owes

 Stockholder’s Equity
> The difference between the value of the firm’s
assets and liabilities

Balance Sheet (cont'd)

 Assets
> Current Assets: Cash or expected to be turned
into cash in the next year
• Cash
• Marketable Securities
• Accounts Receivable
• Inventories
• Other Current Assets
– Example: Pre-paid expenses

Balance Sheet (cont'd)

 Assets
> Long-Term Assets
• Net Property, Plant, & Equipment
– Depreciation (and Accumulated Depreciation)
– Book Value = Acquisition cost – Accumulated
depreciation
• Goodwill and intangible assets
– Amortization
• Other Long-Term Assets
– Example: Investments in Long-term Securities

3
Balance Sheet (cont'd)
 Liabilities
> Current Liabilities: Due to be paid within the next
year
• Accounts Payable
• Short-Term Debt/Notes Payable
• Current Maturities of Long-Term Debt
• Other Current Liabilities
– Taxes Payable
– Wages Payable

Balance Sheet (cont'd)

 Net Working Capital

> Current Assets – Current Liabilities

Balance Sheet (cont'd)

 Liabilities
> Long-Term Liabilities
• Long-Term Debt
• Capital Leases
• Deferred Taxes

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Balance Sheet (cont'd)
 Stockholder’s Equity

> Book Value of Equity

• Book Value of Assets – Book Value of Liabilities
– Could possibly be negative
– Many of the firm’s valuable assets may not be
captured on the balance sheet

Balance Sheet (cont'd)

 Market Value Versus Book Value

> Market Value of Equity (Market Capitalization)

• Market Price per Share x Number of Shares
Outstanding
– Cannot be negative
– Often differs substantially from book value

DIFFERENT BALANCE SHEET ANALYSIS

A balance sheet can be analysed either from:

• a capital-employed perspective
all the uses of funds for the company’s operating cycle
and the origin of its sources of funds are shown

• a solvency-and-liquidity perspective
every asset and liability is listed, the difference
between them representing the book value of the
shareholders’ equity

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THE CAPITAL-EMPLOYED ANALYSIS
The purpose of a capital-employed analysis of the balance sheet
is to analyse the capital employed in the operating cycle
and how it is financed

The balance sheet is divided in:

• fixed assets
• working capital
– operating working capital
– (non-operating working capital)
• shareholders’ equity
• net debt

CAPITAL EMPLOYED AND INVESTED CAPITAL

FIXED ASSETS SHAREHOLDERS’ EQUITY

+ OPERATING WORKING + NET DEBT
CAPITAL (non current liabilities
(current assets – cash)
– current liabilities
= INVESTED CAPITAL
– cash )
= CAPITAL EMPLOYED

Capital employed = Invested capital

CAPITAL-EMPLOYED ANALYSIS
2008 2009
Fixed assets (A)
Inventories
+ Accounts receivables
– Accounts payables
= Operating working capital
+ Nonoperating working capital

= Working Capital (B)

CAPITAL EMPLOYED (A+B)
Shareholders’ equity (C)
Short-, medium- and long-term bank and other borrowings
– Marketable securities
– Cash and equivalents
= Net debt (D)
INVESTED CAPITAL (C+D) = CAPITAL EMPLOYED (A+B)

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THE SOLVENCY-AND-LIQUIDITY ANALYSIS
The purpose of a solvency-and-liquidity analysis of the balance
sheet is to analyse the liquidity and the solvency of the
company

• liabilities are classified in the order in which they fall due for
repayment:
– due in the short term (less than 1 year)
– due in the medium and long term (more than 1 year)

• assets are classified by duration/maturity date:

– liquid (monetised in 1 year)
– fixed (not intended for sale)

THE LIQUIDITY ANALYSIS

Liquidity = ability of a company to meet its commitments
up to a certain date by monetising assets in
the ordinary course of business

Liquidity derives from the fact that the turnover of assets is

faster than the turnover of liabilities

but

while the maturity schedule of liabilities is known in advance,

the liquidity of current assets is unpredictable

THE SOLVENCY ANALYSIS

Solvency = ability of a company to honour its

commitments in the event of liquidation

If a company
owes more than
what it owns

its shareholders’
equity is negative

the company is
insolvent

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THE SOLVENCY ANALYSIS AND NET ASSET VALUE

Net asset value = balance of total assets and

(or book value of total liabilities
shareholders’ equity)

FIXED ASSETS
+ CURRENT ASSETS
– ALL BORROWINGS OF ANY KIND
= BOOK VALUE OF EQUITY

CONCLUSIONS

The balance sheet shows the wealth that has been

accumulated by a company up to a given point in time.

An analyst can conduct either a capital-employed

analysis or a liquidity-and-solvency analysis of the
balance sheet.

The former is used to investigate on capital employed

in the operating cycle and how it is financed, the latter
to evaluate its level of liquidity and solvency.