The return on total capital compares the profitability of a business to the aggregate amount of funds invested in it. The concept is most applicable to businesses that use large amounts of debt in their capital structure. These entities employ leverage to achieve a high return on equity. To see how they are performing when using all forms of funding, we use the return on total capital.
The formula for the return on total capital is to divide earnings before interest and taxes by the aggregate amount of debt and equity. The calculation is:
Earnings Before Interest and Taxes ÷ (Debt + Equity)
For example, a business has generated $150,000 of earnings before interest and taxes. As of the end of the reporting period, it has $300,000 of debt and $700,000 of equity. Its return on total capital is:
$150,000 Earnings Before Interest and Taxes ÷ ($300,000 Debt + $700,000 Equity)
= 15% Return on total capital
The measurement can be altered to use operating profit, if there are stray profitability results from financing and other activities that are materially skewing the results. For example, there may be a large amount of derivative-based income that masks an operating loss.