Definition: The Capital Employed Turnover Ratio shows how efficiently the sales are generated from the capital employed by the firm. This ratio helps the investors or the creditors to determine the ability of a firm to generate revenues from the capital employed and act as a key decision factor for lending more money to the asking firm.
The formula to compute this ratio is:
Capital Employed Turnover Ratio = Net Sales/ Capital Employed
Where, Capital Employed = Net worth + Long-term Borrowings
Net Worth = Share Capital + All Reserves
Higher the ratio better is the utilization of capital employed and shows the ability of the firm to generate maximum profits with the minimum amount of capital employed.
Example: Suppose a firm has a net sales of Rs 50,000 and reported a net worth of Rs 4,00,000 and the long term borrowings amounting to Rs 20,000 in the balance sheet of the firm. The capital employed turnover Ratio will be:
Capital Employed Turnover Ratio = 50,000/4,20,000 = 0.12 times
Capital employed = 4,00,000 + 20,000 = 4,20,000
Mubeen Ansari says
Propose to use of Average capital employed and not capital employed as at reporting date.
Megha M says
In practice, the investors use average capital employed to determine the profitability of the firm from the new investments made in the capital. The average capital employed is majorly used in the industries which are capital sensitive. In this case, the average of opening and closing capital for the specific period is taken into the consideration while in the capital employed only the capital at the end is included in the calculation.
But, for calculating the capital employed turnover ratio we use the capital employed because while using the average capital employed one has to be cautious with respect to the capital assets which depreciates over the passing time. If the assets yield the same amount of profit over every period, then the depreciation will give an inflated average capital employed, which is wrong. This will be misinterpreted as the company is making a good use of the capital although no new investments are being made.
Ajay k says
Will surplus be added to net-worth ? or reserves is only taken