5.4.1 The Main Elements of a Statement of Financial Position - Capital Employed

This section focuses on understanding the concept of capital employed, a crucial element within the Statement of Financial Position (also known as the Balance Sheet). It represents the total amount of money that a business has available for use in its operations.

What is Capital Employed?

Capital employed is the funding used by a business to generate goods or services. It essentially shows how much investment has been made in the business to support its day-to-day activities and long-term growth.

How is Capital Employed Calculated?

Capital employed is calculated as follows:

Capital Employed = Shareholder Equity + Long-term Borrowings

Let's break down each component:

• Shareholder Equity: This represents the owners' stake in the business. It includes items like share capital (money invested by shareholders) and retained earnings (accumulated profits that have not been paid out as dividends).
• Long-term Borrowings: This refers to money borrowed by the business with a term of more than one year. Examples include bank loans, mortgages, and bonds.

Understanding the Components in More Detail

Shareholder Equity

Shareholder equity represents the residual interest in the assets of the business after deducting liabilities. It's what would be left for the owners if all the assets were sold and all the liabilities were paid off.

Long-term Borrowings

Long-term borrowings are a significant source of funding for many businesses, particularly for investments in fixed assets like property, plant, and equipment.

Table Summarizing Capital Employed

Component	Description	Example
Shareholder Equity	Represents the owners' investment in the business.	Share Capital: £50,000; Retained Earnings: £20,000
Long-term Borrowings	Money borrowed for a period longer than one year.	Bank Loan: £30,000; Mortgage: £100,000
Capital Employed	The total funding available for business operations.	Calculation: £50,000 + £20,000 + £30,000 + £100,000 = £200,000

Why is Capital Employed Important?

Capital employed is a key indicator of a company's financial health and stability. It provides insights into:

• Financial Leverage: A higher capital employed can indicate a greater reliance on borrowed funds, which can increase financial risk.
• Investment Capacity: A larger capital employed suggests the business has more funds available for investment in new projects or expansion.
• Solvency: It helps assess the company's ability to meet its long-term obligations.

Example

Consider a small retail business. Its Statement of Financial Position might show:

• Share Capital: £10,000
• Retained Earnings: £5,000
• Bank Loan (5 years): £15,000

Therefore, the capital employed would be: £10,000 + £5,000 + £15,000 = £30,000.