What is capital, when looking at a company? Well, there are two ways to look at this from the start. You can start with sources of finance and then you can look how a company has used that finance. So let's look at our sources of finance first. The first one here is equity. A company may go to its shareholders and say, "Hey, we'd like some money, please?" Shareholders invest some money. In this case, 100, that's called a company's equity. Another source of finance can be debt. Maybe the company's gone to the bank or maybe to bond markets and borrowed 50. Initially, that looks like the company's capital. 100 plus 50 gives us 150. However, the company may not have actually used all of that 150 yet. It may have, some of it, just sat around at the bank doing nothing.

So we need to subtract off any non-operational assets like these. In this example, we've got cash sat at the bank of 20.

So our invested capital in this case is the 100 plus 50 minus 20 equals operational assets of 130.

This leads us to two definitions. The first one is invested capital, which is the 100 plus the 50 minus the 20 equals 130 or it can be called capital employed. Capital employed is just the value of those operational assets. And to give its full title, it's actually net operational assets. Now, all of these figures can be found on a company's balance sheet. These are known as the book values of these numbers. There is a book value of 100. There's a book value of debt of 50. Sometimes it can be quite tempting to look at the up-to-date market value of these numbers. Equity's a good example. Maybe a year ago, shareholders invested 100 in the equity of this business, but today that equity has soared in value and it's now worth 1,000, 10,000, 100,000. Which number should we be using when looking at invested capital or capital employed? We should be looking at the book value on the balance sheet because we want to work out what return the company's earned on that amount that was invested, not its value today on the stock exchange, 'cause the company has not seen the benefit of the equity soaring in value to 100,000. It only had 100 to invest and that's what it's been earning its return on. So we use the balance sheet figure here of 100 of equity, 50 of debt, 20 of cash, and the 130 of operational assets.