Invested capital refers to the total amount of money that has been contributed to a company by its equity shareholders and debt holders, used to fund the company’s operations and growth. Invested capital is a measure of the total investment that has been made in the company, irrespective of whether the funding was obtained through equity issuance or debt borrowing.
The formula to calculate invested capital is typically:
Invested Capital = Total Equity + Total Debt – Cash and Cash Equivalents
- Total equity refers to the shareholders’ equity, which includes the amount of money initially invested plus any retained earnings.
- Total debt includes both long-term and short-term debt obligations.
- Cash and Cash Equivalents are subtracted because they can be seen as non-operating assets, or assets not invested in the company’s operations.
Invested capital is often used in financial analysis to calculate metrics such as Return on Invested Capital (ROIC), which compares a company’s operating profit to its invested capital to assess efficiency and profitability.
It’s important to note that there can be some variations in how invested capital is calculated, depending on how certain items are treated, such as leases, pension liabilities, and minority interest. Therefore, when using or comparing invested capital figures, it’s important to understand how they were calculated.
Example of Invested Capital
Let’s consider a fictional company named “TechVentures Ltd.” and calculate its invested capital:
- Total Equity: Suppose TechVentures Ltd. has shareholders’ equity of $5,000,000. This equity includes the total amount of capital contributed by shareholders, as well as any retained earnings that the company has chosen to reinvest in the business.
- Total Debt: In addition to equity, TechVentures Ltd. has also borrowed funds to finance its operations. Suppose its total debt (both long-term and short-term) is $2,000,000.
- Cash and Cash Equivalents: TechVentures Ltd. has cash and cash equivalents worth $500,000.
By using the formula for invested capital (Invested Capital = Total Equity + Total Debt – Cash and Cash Equivalents), we can calculate:
Invested Capital = $5,000,000 (Equity) + $2,000,000 (Debt) – $500,000 (Cash and Equivalents) = $6,500,000
So, the invested capital of TechVentures Ltd. is $6,500,000. This represents the total amount of capital that has been invested in the company from both debt and equity, minus cash and cash equivalents.
Remember that invested capital represents the amount of money that’s being used in the business, so we subtract cash and equivalents since they are not typically viewed as actively invested in the business operations.