What is Invested Capital?

Invested Capital is the combined value of equity and debt capital a firm raises. Companies raise capital by issuing securities to equity shareholders, issuing debt to bondholders, or receiving a loan from a bank. A company can be entirely financed by debt, entirely financed by equity, or a mix of both. Capital investments are vital for a company’s long-term success; this metric also allows analysts and investors to evaluate a company’s return on investments, capital structure and long-term financial sustainability.

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\[\text{Invested Capital} = \text{Equity} + \text{Debt} + \text{Capital Leases}\]

Equity

Shareholders invest in public companies by purchasing equity shares, or common stock. These shares represent a portion of company ownership and give shareholders voting rights and rights to company earnings and assets. If the value of equity shares increases over time, investors hope to realize capital gains after liquidating equity shares.

Preferred stock is also an alternative solution to raising capital. Preferred stock is a type of equity share that gives shareholders more protection and rights compared to common stock shareholders. Companies can offer preferred shares to an exclusive group of investors, such as venture capitalists and strategic partners. Although they do not have voting rights, preferred stockholders receive their share of earnings, assets and dividends before common stock shareholders.  

Private equity is an option for private companies that wish to raise capital by offering shares of the company to investors.  Private equity can take various forms, such as private stock options, restricted stock or employee stock ownership plans.

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Debt

Companies that choose to finance with debt can issue debt to bond holders or receive a loan from a bank. Bondholders invest in a company by purchasing corporate bonds in exchange for periodic interest payments and full repayment of the principal amount (original price of bond) after the bond matures. Similarly, banks lend companies funds to finance business operations in exchange for repayment of the full loan amount plus interest to be repaid after a specified amount of time.

Private debt, or private credit, is available to private companies that wish to borrow directly from a single lender or small group of lenders.

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Capital Leases

A capital lease is a contractual agreement entitling a renter to the temporary use of an asset; it transfers most ownership benefits and risks to the lessee. On financial statements, a capital lease is treated like a loan used to purchase an asset.

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Examples of Invested Capital

Companies use Invested Capital to acquire long-term assets or invest in working capital (i.e. assets used in everyday business operations). Managers make investment decisions based on the long-term goals of a company and to increase efficiency. This can include purchasing equipment or land, developing new products or entering new markets, as in the following examples:  

• A public company raises additional capital to expand into a new geographical region and sells one million shares to raise $20 million (shown in the “Investment Income” section of the income statement and "Shareholders' Equity"/"Equity" section of the balance sheet).

• A company raises additional capital to purchase new technology to increase efficiency and sells $15 million worth of bonds with a coupon of 3% (shown on “Gain/Loss on Trading Securities" line within the Operating Income section of the income statement.

• A company leases machinery for 10 years, with monthly lease payments in the amount of $1,000. At the end of the term, the company has the option to buy it at a low price. (shown on the “Interest Expense” and Depreciation Expense” lines of the income statement; the leased asset is recorded as a fixed asset, and the lease liability is recognized as debt on the balance sheet).

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