What Is Invested Capital?
Let me explain invested capital to you directly: it's the total amount of money a company raises through equity and debt to fund its operations and long-term growth. This represents the resources provided by investors and lenders, and it's a crucial indicator of the company's financial health and strategic direction.
You can gauge how well a company uses this capital to generate profit through its return on invested capital (ROIC). Note that you won't see invested capital listed directly on financial statements, as debt, capital leases, and stockholders' equity appear separately on the balance sheet.
Key Takeaways
- The combined value of equity and debt raised by a company make up invested capital.
- Invested capital is used for a company's growth and ongoing operations.
- Companies use their invested capital to buy assets and generate profits.
- You can measure how well a company uses its invested capital with its return on invested capital.
Understanding Invested Capital
Companies need to generate earnings that exceed the cost of raising capital from bondholders, shareholders, and other sources; otherwise, they don't achieve an economic profit. I recommend looking at metrics like return on invested capital, economic value added, and return on capital employed to evaluate capital usage.
A firm's total capitalization is the sum of debt, including capital leases, plus equity sold to investors, reported in different balance sheet sections. For instance, if IBM issues 1,000 shares of $10 par value stock sold at $30 each, the common stock balance increases by $10,000 in stockholders' equity, and the additional $20,000 goes to paid-in capital.
If IBM then issues $50,000 in corporate bonds, the long-term debt increases by that amount, totaling an $80,000 increase in capitalization from new stock and debt.
How Issuers Earn a Return on Capital
A successful company maximizes the return on the capital it raises, and investors scrutinize how proceeds from stock and debt are used. Consider a plumbing company issuing $60,000 in new shares to buy trucks and equipment; if this leads to more work, earnings rise, allowing dividends that boost investor returns, plus potential stock price gains from increased sales.
Companies might also repurchase previously issued stock using earnings, reducing outstanding shares and equity balance. Analysts focus on earnings per share (EPS), which is net income per share; buybacks decrease shares outstanding, increasing EPS and making the stock more appealing.
Return on Invested Capital (ROIC)
ROIC calculates a company's efficiency in allocating controlled capital to profitable investments, showing how well money generates returns. Compare it to the weighted average cost of capital (WACC) to see if capital is used effectively—this is essentially return on capital.
Expressed as a percentage, often annualized or over trailing 12 months, ROIC should exceed the cost of capital for value creation. If greater than WACC, the firm creates value and trades at a premium; a benchmark is over 2% above cost of capital for value creation evidence.
If ROIC is under 2%, the company destroys value; zero-return firms neither destroy nor have excess for growth. ROIC is vital for valuation, especially in capital-intensive sectors like oil or semiconductors.
How Do You Calculate Capital Invested?
Calculate invested capital as Total Equity + Total Debt (including capital leases) + Non-Operating Cash.
What Is an Example of Capital Invested?
If a private company goes public and sells one million shares to raise $17 million via IPO, that's invested capital. Similarly, issuing $10 million in bonds at 3% coupon is another example. Generally, capital investments include land, buildings, and equipment.
What Is a Good Return on Invested Capital?
A good ROIC is 2% and above; below that, the business is seen as destroying capital.
The Bottom Line
Invested capital fuels a business—it's the money from equity and debt for operations and growth. The true success measure is effective use, and ROIC is a top tool for investors to assess efficiency, profitability, and long-term potential.
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