Capital expenditure

Capital expenditure, or capital expense, or CAPEX is expenses your company incurs to generate benefit in the future. CAPEX goes in contrast with OPEX — which stands for the day-to-day costs of the company.

So, what is capital expenditure? CAPEX is the money you use to buy, upgrade/repair or improve and maintain your physical assets, such as property, buildings, equipment, etc. CAPEX is a one-time, not recurring, cash spending, it is about long-term assets and something that cannot be deducted in full in the year you buy it.

Speaking in practical examples, here is what a CAPEX is: a new roof for your office, a new machine for production, a new factory. Neat accounting and bookkeeping help to meet the budget and timelines for your company’s CAPEX.

Capital expenditure examples and capital expenditure types

Here is a list of what can be characterized as capital expenditure.

  1. Acquiring a fixed tangible asset (for example, a building)
  2. Buying an intangible asset (for example, a patent or a license)
  3. Upgrading an asset you already have — by expanding its capacity or capability (for example, a computer network or some major equipment)
  4. Renovating an asset that does not function — to make it usable for you
  5. Repairing an existing asset — to make it usable once again
  6. Adapting an asset you already have for a new function that it has not been used for before
  7. Starting or acquiring a new business

The relative amount of CAPEX depends on its growth targets and sector. For example, CAPEX of an oil shipment business will be much higher than that of online accounting service.

Willingness to develop and grow will also raise CAPEX figures and judging by this factor, CAPEX can be divided into maintenance (necessary to continue operations as they are now) and growth CAPEX (expenses on new assets, bought to boost your company’s productivity).

Traits of capital expenditures

How to characterise CAPEX and what signs can show you that they are in question?

  1. CAPEX are infrequent and occur less often than once a year
  2. CAPEX are usually of significant value for your company
  3. CAPEX are funded from sources other than the operating budget
  4. CAPEX require special approval, usually decided at a special general meeting
  5. CAPEX require time for preparation and implementation

Capital expenditure formula or how to calculate CAPEX

The formula for calculation CAPEX looks like this (if you still need to count it, because sometimes the figure can be found in the investing cash flow section on the company’s cash flow statement) :

CAPEX = PP&E (current period) - PP&E (prior period) + Depreciation (current period)

The components for the CAPEX formula are gathered from the income statement and the balance sheet.

Current and prior property, plant and equipment (PP&E) figures can be found on the same balance sheet, while depreciation is to be taken from the income statement.

Let’s count a company’s CAPEX for 2019.

  1. The balance sheet shows PP&E for the current period (2019) equals £46,900.
  2. The same balance sheet shows PP&E for the prior period (2018) equals £47,000.
  3. The income statement shows that depreciation in 2019 equals £13,000.

Applying the formula: £46,900 (PP&E (current period)) -  £47,000 (PP&E (prior period)) + £13,000 Depreciation (current period) =  £12,900, and that is the CAPEX for 2019 for the company.

CAPEX Budget

CAPEX planning and budgeting is about estimating the costs and benefits of a particular project. Or any changes you want to introduce into the production process you already have. Planned wisely, CAPEX investments can boost your profits, shorten your CAPEX cycles and also help you get a bigger return on investment.

One of the key steps in drawing a CAPEX budget plan is to specify the capital spending ceiling — or the maximum amount of money your company is ready to spend on acquiring or maintaining a capital asset.

How to analyze capital expenditure

As a figure, CAPEX shows how big your company’s investment in its fixed assets is. Besides this, you can use this figure for a more complex analysis — with the help of several different ratios. Here they are.

Cash flow/capital expenditures ratio or CF to CAPEX ratio shows how ready your company is to acquire long-term assets using free cash flow. A higher ratio means your company has sufficient capital to fund its operations. The formula for CF/CAPEX is сashflow from operations divided by capital expenditures. You can find both of these figures on the cash-flow statement.

Free cash flow to equity ratio of FCFE is also a ratio, where you can find CAPEX to be included into the analysis. This ratio shows how much cash will be available to the equity shareholders of your company after the expenses, reinvestment and debts are paid. The formula for FCFE is Cash from Operating Activities – Capital Expenditures + Net Debt Issued (Repaid). The greater the capital expenditure for a firm, the lower the free cash flow to equity.

Analysis of capital expenditure investment

The point of such an analysis is to find out whether investing in new real estate for your business or upgrading the existing equipment will bring you any return on the investment.

So, acquiring something, keep this in mind:

  1. How much you will spend on the maintenance of the asset
  2. Whether it has enough quality compared to other options
  3. What its future resale value
  4. Whether the action is justified financially in this particular time
  5. The risks you might incur
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