Invested capital

Invested capital is the total of the funds that investors and lenders have provided to a company and that are currently tied up in its operations. It is neither the balance-sheet total nor the market value of the business. It is the part of its resources on which the business is obliged to earn a return: every rouble here either carries interest or belongs to shareholders and has an opportunity cost.

Two routes to the same figure

The measure can be built from the financing side or from the operating side. On the financing side, you take shareholders' equity and all interest-bearing debt, including debt-like obligations such as lease liabilities, and then subtract cash and short-term investments that sit idle and play no part in day-to-day operations. On the operating side, you add up property, plant and equipment, intangible assets, goodwill and operating working capital, meaning inventories and receivables minus non-interest-bearing payables. Both routes should produce a similar result; a gap between them means that some line item has been classified inconsistently.

The figure is not static. It grows with capital expenditure, rises when a change in working capital goes towards higher inventories and longer payment terms for customers, picks up goodwill after acquisitions, and shrinks with depreciation, amortisation and write-offs. A separate source of distortion is the capitalisation of costs: development spending moved from expenses onto the balance sheet as an asset lifts both profit and the denominator at the same time.

An example from the accounts

For Lukoil, the framework of the measure can be seen in two balance-sheet lines: shareholders' equity of 1 110 183 683 000 and total debt of 855 456 539 000. Their sum, less non-operating cash balances, gives the base against which after-tax operating profit is then set to calculate ROIC, and the result is compared with the cost of capital, WACC.

Where the measure stops working

For banks and insurers the concept loses its meaning: the funds they raise are not a source of financing for operations but the very raw material of the business, and it is impossible to separate "interest-bearing debt" from operating liabilities, so return on equity is used for them instead. The second trap is substituting the balance-sheet total for invested capital: the total includes non-interest-bearing payables and an excess cash cushion, the denominator is inflated, and the return looks lower than it really is. Finally, the historical cost of assets at an old plant and at a recently acquired competitor cannot be compared: the same business, after a deal, shows the same cash flow on noticeably larger capital.