Capital expenditure, or CapEx, is a term used in finance to describe the investments that an organization makes into long term assets with the goal of generating future income, such as property, equipment, or technology. Capital expenditure is an essential component of financial planning, capital budgeting, and cash flow management for organizations of all sizes.
In this article, we will define capital expenditure, highlight the differences between CapEx and OpEx, explain how to calculate CapEx, and explore practical examples of CapEx in finance.
What is CapEx?
Capital Expenditure, or CapEx, is the money a company invests in acquiring, upgrading, or maintaining physical assets with the expectation of generating income over a period of time.
Examples of CapEx:
- The purchase of real estate or property
- The acquisition of a manufacturing plant
- Plant, Property, and Equipment (PP&E)
- Software licenses
In comparison to operational expenditures (OpEx), capital expenditures are larger in amount and have a significant long-term impact on the organization’s financial health. Capital expenditures include subset expenditures related to maintaining existing assets, referred to as Maintenance CapEx, and costs associated with expanding business operations, known as Growth CapEx.
CapEx vs OpEx
The main difference between capital expenditure and operating expenditure is the time frame in which they are incurred and their impact on the company’s financial statement, which I will explain.
A capital expense is a long-term investment and is expected to generate income for the organization over a long period of time, usually more than one year. They are recorded on the balance sheet as assets and are depreciated or amortized over their useful life. Operational expenditure, on the other hand, are short-term costs that are necessary for day-to-day business operations. OpEx is recorded on the income statement and is deducted from revenue to determine the company’s net income.
Examples of OpEx:
- Employee wages
- Office supplies
- Consulting fees
Understanding how to correctly classify and budget CapEx and OpEx is essential for strategic decision-making. Capital expenditures represent the foundation for future growth and sustainability, influencing a company’s long term success. In contrast, managing operating expenditures efficiently ensures the smooth running of daily operations and affects short-term profitability.
Capital Expenditure Requests
A capital expenditure request is a form used to request approval for a capital expenditure towards a capital project. This form typically includes details such as the purpose of the expenditure, the expected benefits, and the estimated cost. Through the use of a capital expenditure request form template, organizations can ensure that all necessary information is provided and that the request is evaluated before a decision is made.
By understanding the definition, calculation, formula, and examples of capital expenditure, companies can effectively manage and track their investments in long-term assets. With the use of capital expenditure approval software and integrated capital expenditure request forms, organizations can ensure that these investments are properly evaluated and approved before being implemented.
Types of Capital Expenditure
Let’s explore two common types of capital expenditures: Maintenance and Growth CapEx.
Maintenance CapEx refers to any capital investment made to maintain or restore the existing productive capacity of an asset. These are investments in capital assets that are necessary for ongoing operations and to sustain the asset’s current level of performance.
Examples of Maintenance Capital Expenditure:
- Maintenance of property, plant, and equipment (PP&E).
- Updates to technology and software systems.
- Maintenance of utilities and infrastructure.
- Maintenance of production lines.
- Buying safety equipment.
- Replacement of parts and components.
While regular maintenance expenses are often treated as operating costs, maintenance CapEx involves significant expenditures that are capitalized on the balance sheet because they contribute to the long-term value of the asset.
Growth CapEx is a subset of capital expenditure that specifically refers to investments made with the intention of fostering growth. While all growth capex is a form of capital expenditure, not all capital expenditures are necessarily growth-related.
Growth CapEx is a specific category of capital expenditure focused explicitly on initiatives designed to expand the business, increase capacity, or pursue new growth opportunities.
Examples of Growth Capital Expenditure:
- Building new corporate or operational facilities.
- Buying or acquiring existing businesses.
- Investing in research and development (R&D).
- Upgrading technology to support business expansion.
Read about capital project types and how to classify them.
How to Calculate CapEx
Calculating capital expenditure helps organizations understand how much money has been invested in acquiring or upgrading long-term assets. The CapEx equation provides visibility into the Delta of PP&E, in addition to the cost of depreciating assets. PP&E is an important component of the CapEx calculation to understand; PP&E is an abbreviation for the capital expenditures associated with Property, Plant, and Equipment.
Therefore, the actual result of the CapEx calculation reveals how much money has been invested into the maintenance and creation of fixed assets.
The CapEx Formula:
CapEx = Ending PP&E – Beginning PP&E + Depreciation Expense
Example of the CapEx Formula and Calculation
Let’s say an organization’s beginning capital assets for the year were $500,000, and their ending capital assets were $600,000. They also made additional capital investments of $100,000 during the year. Using the CapEx equation, we can calculate their capital expenditure:
CapEx = (Ending PP&E – Beginning PP&E) + Depreciation Expense
CapEx = ($600,000 – $500,000) + $100,000
∴ CapEx = $200,000
The capital expenditure calculation reveals that the organization invested $200,000 in creating or maintaining fixed assets that year, which must be recorded on their balance sheet.
Examples of Capital Expenditure in Finance
Let’s explore 3 real-world examples of capital expenditure in finance, such as PP&E, Technology and Software, and Intangible Assets:
1) Property, Plant, and Equipment
One of the most common examples of CapEx is the purchase of property, plant, and equipment (PP&E). PP&E are expected to generate income for the organization over a period of time and is recorded on the balance sheet as assets. They are depreciated or amortized over their useful life, which reduces their value on the balance sheet over time.
Examples of PP&E as Capital Expenditure
- Purchasing real estate or a new office
- Purchasing manufacturing equipment
- Investing in vehicles for transportation
- Investing in a new manufacturing plant
2) Technology and Software
Organizations invest in new technology or software to improve their processes, increase productivity, or stay competitive in their industry. This could include an ERP implementation such as SAP.
Example of Software and Technology as Capital Expenditures
Migrating from SAP to SAP S/4HANA is classified as a capital expenditure, because all software or technology upgrades are incurred as capital expenditures. Therefore, it would be recorded on your balance sheet as an asset.
Learn how organizations distinguish between CapEx and OpEx for SaaS projects.
3) Intangible Assets
Intangible assets are also expected to generate income for the organization and are recorded on the balance sheet as assets. Intangible assets are amortized over their useful life, which can range from a few years to several years, depending on the type of asset.
CapEx Examples of Intangible Assets
Why is Capital Expenditure Important?
Capital expenditure is an essential aspect of financial planning and budgeting for organizations with numerous benefits. It allows companies to invest in long-term assets that will generate future income and contribute to the growth and success of the business.
The following will discuss 4 key reasons why capital expenditure is important to all organizations:
Future Growth and Income
Capital expenditures produce extensive long-term benefits and contribute to the growth and expansion of the business. By investing in a long-term asset, organizations can expand their operations, increase production, and generate higher future cash flows. This is especially important for organizations that are looking to grow and stay competitive in their industry.
Asset Maintenance and Upgrades
Capital expenditures also include the costs of maintaining and upgrading existing assets. This is important for businesses that rely on equipment or technology to operate. By investing in the maintenance and upgrades of these assets, organizations can ensure their continued functionality and avoid capital project failure.
CapEx Tax Benefits
Capital expenditures can also provide tax benefits for organizations. In many cases, these capital investments can be deducted from the organization’s taxable income, reducing their tax liability.
Investors often look at a company’s capital expenditures as a sign of future growth and potential. By investing in long-term assets, companies can show investors that they are committed to the success and growth of their business.
A Conclusion on CapEx
Capital expenditure, or CapEx, is an essential aspect of financial planning and capital budgeting for organizations. It involves investing in long-term assets that are expected to generate income for the company over a period of time, typically over the period of a few years. Capital expenditures have numerous benefits and they are important to the financial success of any organization.
By understanding how to calculate capital expenditure and its importance in finance, organizations can make informed decisions to prioritize capital investments, choose optimal capital projects, enhance cash flow, and contribute to the growth and success of their company. Identifying the difference between capital expenditure and operational expenditure is important, so I encourage you to learn the difference between CAPEX and OPEX for SaaS projects.