The appropriate test for capacity is not whether the employee was working to their personal best, but whether the work was performed satisfactorily when looked at objectively.
The concept of capacity in s.387(a) as a basis for a valid reason for dismissal goes beyond the physical capacity or skill of the employee, and encompasses situations where employees do not have or maintain the necessary licence, certification, qualification, approval or accreditation to lawfully perform the inherent requirements of their job.
Inability to perform the inherent requirements of the position may be a valid reason for the termination of an employee. This issue was considered in J Boag & Son Brewing Pty Ltd v Button: 
Where an employer relies upon an employee's incapacity to perform the inherent requirements of his position or role, it is the substantive position or role of the employee that must be considered and not some modified, restricted duties or temporary alternative position that must considered. [emphasis added].
The situation may arise where an employer dismisses an employee as a consequence of a mandatory assessment by a third party which removes the capacity of the employee to perform an inherent requirement of the job, including where a tradesperson who is required to be licenced has the license cancelled, where a professional fails to maintain their mandatory certification to practise, where a court imposes a custodial sentence on an employee, and when a host employer refuses to accept labour from an employee of a labour hire agency.
In a situation where an employee’s capacity to perform the inherent requirements of their job is affected by the actions of a third party, the employer still has an obligation to treat the employee fairly.
Where an employee cannot perform the inherent requirements of their job and there is no reasonable scope for the employee to be redeployed into another role, it is likely that there will be a valid reason for dismissal based on the employee’s capacity.
The Fair Work Act 2009 protects an employee from being dismissed due to a temporary absence for illness or injury for up to 3 months, or up to 3 months in total over a 12 month period, or where an employee is on paid personal/carer's leave for the duration of the absence.
After 3 months it becomes a question of whether the employee is likely to return to their duties in the short or medium term.
Medical evidence could have a bearing on the adequacy of the reason for termination.
Where an employee has been dismissed for poor performance, another relevant criterion is whether or not they were warned about their performance.
 Walton v Mermaid Dry Cleaners Pty Limited  IRCA 267 (12 June 1996), [(1996) 142 ALR 681 at p. 684].
 Crozier v Palazzo Corporation Pty Limited t/as Noble Park Storage and Transport, Print S5897 (AIRCFB, Ross VP, Acton SDP, Cribb C, 11 May 2000) at para. 62, [(2000) 98 IR 137].
 J Boag & Son Brewing Pty Ltd v Button  FWAFB 4022 (Lawler VP, O'Callaghan SDP, Williams C, 26 May 2010) at para.22, [(2010) 195 IR 292].
 Fair Work Act s.387(e).