• Gross capital employed usually means the total assets, fixed as well as current, used in business, while
  
• Net capital employed refers to total assets minus liabilities.
  

Calculation of Capital Employed:

Method--1. If it is calculated from the assets side, It can be worked out by adding the following:

1. The fixed assets should be included at their net values, either at original cost or at replacement cost after deducting depreciation. In days of inflation, it is better to include fixed assets at replacement cost which is the current market value of the assets.
2. Investments inside the business
3. All current assets such as cash in hand, cash at bank, sundry debtors, bills receivable, stock, etc.
4. To find out net capital employed, current liabilities are deducted from the total of the assets as calculated above.

Gross capital employed = Fixed assets + Investments + Current assets

Net capital employed = Fixed assets + Investments + Working capital*.

*Working capital = current assets − current liabilities.

Precautions For Calculating Capital Employed:

While capital employed is calculated from the asset side, the following precautions should be taken:

1. Regarding the valuation of fixed assets, nowadays it is considered necessary to value the assets at their replacement cost. This is with a view to providing for the continuing problem of inflations during the current years. Under replacement cost methods the fixed assets are to be revalued on the basis of their current market prices either by reference to reliable published index numbers, or on valuation of experts. When replacement cost method is used, the provision for depreciation should be recalculated since depreciation charged might have been calculated on original cost of assets.
2. Idle assets―assets which cannot be used in the business should be excluded from capital employed. However, standby plant and machinery essential to the normal running of the business should be included.
3. Intangible assets, like goodwill, patents, trade marks, rights, etc. should be excluded. However, if they have sale value or if they have been purchased they may be included. Investments made outside the business should be excluded.
4. All current assets should be properly valued. Any excess balance of cash or bank than required for the smooth running of the business should be excluded.
5. Fictitious assets, like preliminary expenses, accumulated losses, discount on issue of shares or debentures, advertisement, suspense account, etc. should be excluded.
6. Obsolete assets which cannot be used in the business or obsolete stock which cannot be sold should be excluded.

Method--2. Alternatively, capital employed can be calculated from the liabilities side of a balance sheet. If it is calculated from the liabilities side, it will include the following items:

Share capital:
     Issued share capital (Equity + Preference)
Reserves and Surplus:
    General reserve
    Capital reserve
Profit and Loss account
Debentures
Other long term loans

Some people suggest that average capital employed should be used in order to give effect of the capital investment throughout the year. It is argued that the profit earned remain in the business throughout the year and are distributed by way of dividends only at the end of the year. Average capital may be calculated by dividing the opening and closing capital employed by two. It can also be worked out by deducting half of the profit from capital employed.