Invested capital equals the sum of all cash that has been invested in a company over its life without regard to financing form or accounting name. It is the total of investments in the business from which operating revenue is derived. It can be calculated two mathematically equivalent ways as shown in Figure 1.
Figure 1: Formulae for Invested Capital
* NIBCLs – stands for Non-Interest-Bearing Current Liabilities
* * Includes leased assets
Source: New Constructs, LLC
When we calculate invested capital, we make numerous adjustments to close accounting loopholes and ensure apples-to-apples comparability across thousands of companies. A company shouldn’t be able to hide from its history, for instance, through write-downs or impairments. For more details, see our Invested Capital Webinar.
Figure 2 shows the companies where adjustments make the biggest difference by showing how much reported total assets differs from our calculation of invested capital.
Petroleo Brasileiro’s (PBR) invested capital is significantly higher than its reported total assets. Our invested capital calculation for PBR can be seen here. The $134 billion discrepancy stems from $88 billion in off-balance sheet operating leases, which we include in invested capital, as well as $27 billion in accumulated asset write-downs. In 2014 alone, PBR wrote down over $20 billion in assets, including a $16 billion impairment, which we identify in our model here.
Time Warner (TWX), Pfizer (PFE), Viavi Solutions (VIAV), and Exxon Mobil (XOM) are the other companies with the most understated reported total asset value. All the adjustments made to TWX’s total assets, in order to calculate invested capital, can be found here. In each company model, we also show how to convert GAAP Net Income to NOPAT. We believe transparency always helps investors, which is why all our calculations are visible throughout each company model. See the adjustments made to XOM”s total assets here and the invested capital calculation here.
On the other hand, Mitsubishi UFJ Financial (MTU) invested capital is significantly lower than its reported total assets. See our invested capital calculation for MTU each year dating back to 2013 here. The discrepancy comes from how we treat the investment liabilities for financial companies like Mitsubishi. We make multiple, special adjustments to our models to reflect the different accounting in different sectors and regions of the world. We focus on the economics of business, and, in the process, our models transcend the accounting loopholes and idiosyncrasies that make building good models difficult.
Our models and calculations are 100% transparent because we want our clients to know how much work we do to ensure we give them the best earnings quality and valuation models in the business.
Bank of America (BAC), Freddie Mac (FMCC) JPMorgan Chase (JPM) and HSBC Holdings (HSBC) round out the companies with the most overstated reported total assets.
Below are the primary accounting distortions in reported financial statements that require economic translation and adjustment for the Invested Capital calculation.
- Add back off-balance sheet reserves
- Add back off-balance sheet debt due to operating leases
- Remove discontinued operations
- Remove accumulated Other Comprehensive Income
- Add back asset write-downs
- Remove deferred compensation assets and liabilities
- Remove deferred tax assets and liabilities
- Remove under or over funded pensions
- Remove excess cash
- Prior to 2002: Add back unrecorded and accumulated goodwill
- Adjust for midyear acquisitions
- Remove non-operating unconsolidated subsidiaries
Average Invested Capital is the average of beginning and ending invested capital. If the company discloses the purchase price and closing date of an acquisition, we weight the acquired invested capital by the percent of the fiscal year the acquisition was held.
Invested Capital Turns = Total Operating Revenue/Invested Capital
See our webinar on importance of ROIC and how to calculate it.
Here is our report on “ROIC: The Paradigm For Linking Corporate Performance to Valuation.”