What Does Invested Capital Mean?
Invested capital is the total amount of investments made by both shareholders and bondholders in a company. It is a liability for a company since it has to pay this money as well as a reasonable return back to both the shareholders and bondholders, though in the case of the latter, the rate of return is fixed. Before it can start making a profit, a company needs to make more money than the total of its invested capital in addition to the money needed to service it.
Divestopedia Explains Invested Capital
Invested capital is an important metric for both investors and business owners. For a company, it helps to determine its liabilities and the amount of money it needs to make in order to cover these liabilities. From an investor's perspective, the invested capital is useful in calculating the return on investment, value addition and the return on capital used by the company. Based on these metrics, the investors can make informed decisions.
The formula is as follows:
Invested Capital = Total Debt + Lease + Total Equity - Non-operating Cash and Investments
Though the above formula is the most commonly used, it is not the only way to calculate invested capital. There are two approaches, which include operating and financial. In the operating approach, current liabilities that are not interest bearing are subtracted from current operating assets in order to calculate the net working capital. Property and equipment costs; present value of lease obligations that are not capitalized; goodwill and other intangible assets are then added to the net working capital in order to arrive at the invested capital amount.
In the financial approach, short term debt of the company, long term debt and lease obligations that are not capitalized are added together to arrive at the total debt and leases. Common stock; earnings; bad debt reserves, if any; and other capitalized expenses, including marketing, and research and development, are then added to the total debt and leases. Finally, marketable securities are subtracted from this value to arrive at the final value of invested capital.