25 September 2016
how to calculate average capital employed when opening balance of general reserve and profit and loss given whether to use such info for calculating profit and applying 1/2 profit formula or calculating opening capital and then doing average
14 July 2024
Calculating average capital employed involves determining the average amount of funds invested in a business over a specific period. Here’s how you can approach it, considering the factors you mentioned:
### Average Capital Employed Calculation:
1. **Opening Capital Employed:** - Typically, the opening capital employed is calculated as the sum of equity capital, reserves (including general reserve), and long-term borrowings. - It can be calculated as: ``` Opening Capital Employed = Equity Capital + Reserves + Long-term Borrowings ``` - **Equity Capital:** The initial investment made by the owners/shareholders. - **Reserves:** Accumulated profits retained in the business, including the opening balance of the general reserve. - **Long-term Borrowings:** Loans or debts with a maturity period exceeding one year.
2. **Average Capital Employed:** - To find the average capital employed, you typically calculate the average of the opening and closing capital employed for the period: ``` Average Capital Employed = (Opening Capital Employed + Closing Capital Employed) / 2 ``` - **Closing Capital Employed:** Calculated similarly to opening capital employed at the end of the period.
3. **Profit Consideration:** - Regarding the profit to use in the formula: - **Profit Before Tax (PBT):** This is usually used to calculate the return on capital employed (ROCE) because it reflects the operating performance of the business before accounting for taxes. - **Average Profit Before Tax:** You would calculate the average PBT over the period to use in the ROCE formula. ``` Average PBT = (PBT at beginning of period + PBT at end of period) / 2 ```
4. **1/2 Profit Formula (for Return on Capital Employed):** - Return on Capital Employed (ROCE) is often calculated using the formula: ``` ROCE = (Profit Before Tax / Average Capital Employed) * 100 ``` - Here, average capital employed is derived as discussed above.
### Example Approach:
Let's say you have the following details: - Opening Capital Employed: ₹1,000,000 - Closing Capital Employed: ₹1,200,000 - Profit Before Tax (PBT) for the year: ₹200,000
To calculate average capital employed: ``` Average Capital Employed = = 1,100,000 ```
To calculate average PBT: ``` Average PBT = (PBT at beginning + PBT at end) / 2 = (PBT for the year + PBT for the year) / 2
= 200,000 ```
Then, using the average capital employed and average PBT, you can calculate ROCE.
### Conclusion:
- **Calculation Approach:** Use the average of opening and closing capital employed for the period. - **Profit for ROCE:** Use profit before tax (PBT) to calculate ROCE.
This method provides a standardized way to evaluate the efficiency of capital utilization over a specific period, taking into account fluctuations in capital and profitability. Adjustments may be necessary based on specific reporting requirements or additional factors relevant to your business context.
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