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Capital Expenditure (CapEx) is the expenditure made by a firm to improve its long-term assets, purchase new equipment, or facilitate growth in the foreseeable future. It serves as a potent financial metric and helps financial analysts understand a company’s investment patterns.
CapEx is the money invested by a company in acquiring, maintaining, or improving fixed assets such as property, buildings, factories, equipment, and technology. CapEx is included in the cash flow statement section of a company’s three financial statements, but it can also be derived from the income statement and balance sheet in most cases.
CapEx is often used to undertake new projects or investments by a company. Capital expenditures for fixed assets can include repairing a roof if the useful life of the roof is extended, purchasing a piece of equipment and building a new factory.
Capitalizing an asset requires that the company spread the cost of the expenditure over the useful life of the asset. The amount of capital expenditures a company is likely to have depends on its industry. Some of the most capital-intensive industries have the highest levels of capital expenditures. They include oil exploration and production, telecommunications, manufacturing, and utility industries.
CapEx is employed to improve operational efficiency, increase revenue in the long term, or make improvements to the existing assets of a company. Capital spending is different from other types of spending that focus on short-term operating expenses, such as overhead expenses or payments to suppliers and creditors. It is primarily a one-time investment in non-consumable assets used to maintain existing levels of operation within a company and to foster its future growth.
Such expenditures affect the organization positively over time by enhancing growth rates, profitability levels, and operational abilities. The resources for the capital expenditure are normally determined using crucial factors such as ROI, potential cash flow variance, risk assessment, and the overall financial integrity of the investment.
Such expenditures are classified into three categories:
There are different types of capital expenditures, which include:
If you have access to a company’s cash flow statement, no calculation is necessary; you can simply see the capital expenditures made in the investing cash flow section.
However, if you don’t have access to the cash flow statement, you can calculate the net capital expenditure if depreciation is broken out on the income statement (which most, but not all, companies do).
To calculate capital expenditures, adhere to the steps listed below:
The CapEx formula from the income statement and balance sheet is:
Where, CapEx = Capital expenditures
PP&E = Property, plant and equipment
This formula is derived from the logic that the current period PP&E on the balance sheet is equal to the prior period PP&E plus capital expenditures less depreciation.
Note: This formula will generate a “net” capital expenditure number, meaning if there are any dispositions of PP&E in the period, they will lower the value of CapEx that is calculated with the formula.
Below we’ve presented an example of how to calculate capital expenditures as it applies to financial modeling in Excel:
Let’s have a look at CapEx in 2018 as well as the following information:
Now, calculate the capital expenditure using the formula listed above:
CapEx = PP&E (current period) – PP&E (prior period) + Depreciation (current period)
CapEx = $37,508 – $37,513 + $15,005
CapEx = $15,000
The table given below shows a clear idea about the key difference between the capital expenditure and revenue expenditure in a firm:
| CapEx | OpEx (Revenue expenditure) |
| Capital expenditures are long-term in nature that adds value for the future growth including real estate, machinery, equipment, furniture, vehicles etc. | Revenue expenditures are short-term in nature used for day-to-day business operations, such as rent, wages, license fees and utilities. |
| CapEx usually can be seen on the Cash flow statement of a company and on the balance sheet, it appears under the header of fixed assets. | OpEx displays on the Income statement of a firm and not is reported on the balance sheet. |
| Such expenses aim to improve a firm’s earning capacity. | These expenses only focus on sustainable earnings. |
| CapEx is reported as an asset. | OpEx is reported as an expense. |
| Capital expenditures are non-recurring and not easily reversible, which means companies are not likely to recover the initial value of an asset even if they decide they no longer need it. | Such expenses are incurred frequently and are easily reversible, which means companies can recover the initial value of a purchase more easily through the cancellation process. |
| Capital expenditures are capitalized. | Revenue expenditures are not capitalized. |
| Depreciation is charged on capital expenditure every year. | Depreciation is not usually charged on revenue expenses. |
| These expenses are not tax-deductible. | Operating expenses are fully deductible from the company’s tax in the same year in which the expenses occur. |
Capital expenditure, also abbreviated as “Capex,” describes the funds spent by a company to acquire, upgrade, and maintain physical fixed assets, such as property, buildings, and equipment.
For example, the act of repairing a roof, building a new factory, or purchasing a piece of equipment would each be categorized as a capital expenditure.
Capital Expenditure (Capex) → Capex is distinct from an operating expense (Opex) as the underlying asset – i.e. the fixed asset associated with the capital spending – is expected to generate long-term benefits in excess of 12 months.
Operating Expenses (Opex) → In contrast, operating expenses refer to the indirect costs incurred in the ordinary course of business, such as selling, general, and administrative (SG&A) expenses.
For example, wages and salaries, rent and utilities, equipment repair and lease, etc. All of these expenses benefit the company in the short term.
Many types of assets can attribute long-term value to a company. Capital expenditure falls into two categories: tangible and intangible assets.
Below are a few examples of both:
The asset that contributes short-term value to a company is known as operating (revenue) expenditure. For example, when rent is paid on a warehouse or office, the company using the space gets the benefit of the space for a given period (i.e., one month). Here, just because the benefit is received for the short term, the cost is OpEx.
Below are some examples of Opex, which include:
CapEx is reported on the balance sheet as a capitalized asset. Most CapEx assets are depreciated, which means an expense related to the asset is recognized each year evenly over its useful life. Some CapEx, such as land, is not depreciated.
On the other hand, OpEx is reported on the income statement and is expensed immediately. As there is no long-term value to OpEx, it must be expensed in the period in which it is incurred. OpEx is not depreciated over its useful life, and the entire expense is recognized right away.
The expenditure is capital or expense totally depends on how long the benefit of that spending will be expected to last. If the benefit is less than 1 year, it must be expensed directly on the income statement. However, if the benefit is more than 1 year, it must be capitalized as an asset on the balance sheet.
For instance, the purchase of any office appliances like printer ink and paper would not fall under investing activities on the cash flow statement but would instead be an operating expense on the income statement.
Unlike it, the purchase of a building would provide a benefit of more than one year and would thus be deemed as a capital expenditure.
Capital expenditure can be found on a company’s cash flow statement under investing activities.
As you can see in the screenshot below from Amazon’s 2022 annual report, Amazon had $63,645 million in capital expenditure related to “purchases of property and equipment (PP&E).
Since this spending is considered an investment, it does not appear on the income statement.
CapEx is all about revenue if the expenditure benefits your company, it will be listed as capital and in the following example you can notice how much Amazon spent on PP&E to grow their business for getting more returns.
CapEx flows from the cash flow statement to the balance sheet. Once it’s capitalized, the value of the asset is slowly reduced over time via depreciation expense. Capital expenditures are recorded in property and equipment (PE) line items, which represent long-term assets such as buildings, vehicles, or machinery. The value of such assets slowly depreciates over time. In the assets section of the balance sheet, the capex amount will be captured as an increase to the PP&E balance and reduced by the non-cash depreciation expense.
Net CapEx refers to the remaining funds used to obtain or enhance fixed assets after deducting the revenue generated from selling fixed assets. It is a difference between overall capital expenditure and the earnings from selling fixed assets.
Such expenditure helps in evaluating the efficiency of capital allocation, assessing the impact on the company’s asset base, and understanding the overall investment trends over time. It can be calculated either directly or indirectly.
In the direct approach, an analyst must add up all of the individual items that make up the total expenditures using a schedule or accounting software.
In the indirect approach, the value can be inferred by looking at the value of assets on the balance sheet in conjunction with depreciation expense.
| XX Amount spent on asset | + XX amount spent on asset | + XX amount spent on asset | − Value received for assets that were sold | = Net CapEx |
| PP&E Balance in the current period | − PP&E balance in the previous period | + PP&E balance in the previous period | = Net CapEx |
CapEx and depreciation are closely related financial metrics. When managing and assessing a company’s assets and expenses, you are always recommended to monitor Capex and depreciation. When capital expenditures are used over some time, they are automatically depreciated.
Depreciation refers to the reduction in the value of long-term assets over time. Capital expenditure and depreciation are interconnected because CapEx investments in long-term assets are subjected to depreciation.
When a company invests in CapEx, the cost is recorded as a long-term asset on the balance sheet. Over time, the value of this asset is gradually decreased through depreciation expense, reflecting the asset’s consumption or value.
The total depreciation will be equal to the net capital expenditure. If a company regularly has more CapEx than depreciation, its asset base is growing.
Here’s how to see if a company is growing or shrinking (over time):
CapEx > Depreciation = Growing Assets
CapEx < Depreciation = Shrinking Assets
CapEx plays a key role in enabling stakeholders to determine the profitability of their assets. It helps businesses to grow and ensures sustainability.
Below are some pointers to describe the importance of capital expenditure in a firm:
CapEx allows companies to invest in growth opportunities that contribute to their long-term sustainability. The range of current production or manufacturing activities is mainly a result of past capital expenditures. Similarly, the current decisions on capital expenditures will have a major influence on the future activities of the company.
Capital expenditures are often difficult to reverse without the company incurring losses. Most forms of capital equipment are customized to meet specific company requirements and needs. Also, such customized materials and machinery do not bode well in the general capital market.
Capital expenditures are characteristically very expensive, especially for companies in industries such as manufacturing, telecom, utilities, and oil exploration. Capital investments in physical assets like buildings, equipment, or property offer the potential to provide benefits in the long run but will need a large monetary outlay initially.
Capital expenditures have an initial increase in the asset accounts of an organization. However, once capital assets start being put in service, depreciation begins, and as a result their value continues to decrease throughout their useful lives.
Cash expenditure plays a crucial role in budgeting and financial planning. By monitoring and analyzing cash outflows, businesses can develop realistic budgets and forecast future cash requirements. Also, can ensure they have sufficient funds to meet their day-to-day expenses, such as payroll, rent, utilities, and supplier payments.
Cash expenditure is a critical factor when evaluating investment decisions. Businesses can assess the feasibility and profitability of a project. Analyzing the cash expenditure associated with various investment options helps to determine the potential return on investment (ROI). This enables you to make better decisions regarding resource allocation, investment opportunities, and cost management strategies.
Here are some common challenges that business entities encounter with capital expenditure –
Business entities and financial experts often face problems when it comes to identifying, measuring and estimating the costs involved and benefits of a capital expenditure proposal.
Most large investments are made in capital assets with the hope of generating predictable outcomes. However, such outcomes are not guaranteed, and losses may be incurred. The costs and benefits of capital expenditure decisions are usually characterized by a lot of uncertainty. Even the best forecasters sometimes make mistakes.
Organizations need to account for risks to reduce potential losses during financial planning, even though it is not possible to eliminate them.
The cost and benefit of CAPEX are spread over an extended period. As a result, the temporal spreads often rise when estimating the discount rate and establishing equivalence.
Negative and positive CapEx represents how capital expenditures are displayed in the company’s cash flow management.
A negative CapEx represents a reduction in the company’s capital base and typically occurs when assets become obsolete, are no longer needed, or are sold for strategic reasons. It refers to situations where a company sells or disposes of existing capital assets.
The example of negative CapEx is when a factory owner realizes that they don’t need 200+ workers anymore. The work can be done by only 20 workers at a time, and the workers they currently have are not being used for any productive purposes.
Positive CapEx leads to the more common scenario where a company invests in acquiring new assets or upgrading existing ones. Positive CapEx aims to enhance a company’s capabilities, productivity, or market position, contributing to future growth and profitability.
The most common example of positive CapEx is when the business decides to expand an already existing factory that has to increase its production capacity.
CapEx is the investments that a company makes to grow or maintain its day-to-day business operations. Capital expenditures are less predictable than operating expenses, which recur consistently from year to year. A company that buys expensive new equipment would account for that investment as a capital expenditure. It would, therefore, depreciate the cost of the equipment throughout its useful life.
Capital expenditures aren’t directly tax-deductible but they can indirectly reduce a company’s taxes through the depreciation they generate. A company may include $100,000 of depreciation expense each year for 10 years if it purchases a $1 million piece of equipment with a useful life of 10 years. This depreciation would decrease the company’s pre-tax income by $100,000 annually, reducing its income taxes.
Companies often incur capital expenditures to invest in their long-term capabilities. They must carefully plan and execute their capital expenditure strategies to make a balance between expanding their operational capabilities and maintaining financial health. CapEx can tell you how much a company invests in existing and new fixed assets to maintain or grow its business.
From buying land, buildings, and equipment to enhancing manufacturing or warehouse opportunities or technology, CapEx includes everything that brings revenue to the company.
If an asset is likely to deliver long-term benefits to a company, the company may be required to record the purchase or development as a capital expenditure, depreciate the asset over its useful life, and maintain part of the purchase on its balance sheet.
