What is Capital Expenditure?

Capital Expenditure (CAPEX) is the amount of financial resources that a company uses to purchase capital goods with the aim of expanding the operational scope of the company. 

Examples of CAPEX include building a new plant or buying vehicle fleets to improve production.

Back to: Accounting & Taxation

Back to:BUSINESS & PERSONAL FINANCE

How is CAPEX Used?

In the business world, CAPEX refers to the expenses incurred by a company to purchase capital goods. The objectives is to improve the status of the company through the purchase of new assets or by valuation of existing fixed assets. Buying new computers, office suppliers, or delivery vans are examples of CAPEX. 

Another meaning of CAPEX is the amount of cash that a company spends in keeping its assets stable and operational thereby influencing the overall output of the organization. 

In accounting, expenses are only regarded to as capital expenses once the existing assets start depreciating or accruing amortization costs. This is so because in accounting, every company should discount its fixed costs with depreciation and amortization against the life of an asset. 

It is also noted in accounting that precise expenses that cover investments are capitalized if they increase an asset value. The capitalized expense should be distributed throughout the life cycle of the asset.

The Importance of CAPEX

Companies use CAPEX as an indicator of the life cycle stage that an organization is at a particular time. When a company begins, the CAPEX is usually high since the company would need series of equipment goods for production. In case the company develops quickly, the CAPEX will be greater than the depreciations of the fixed assets, which is an indication of the rapid rising of capital goods. However, in the case that the CAPEX is lower than or similar to the depreciations, then the company is decapitalizing and would eventually decline.

Where to find CAPEX statement

Companies can obtain their CAPEX statements from the cash flow statement generated from investing activities. There are several ways that companies can name CAPEX line in their cash flow statements including:

• Capital expenditures
• Expenses of acquisitions
• Acquisitions of plant, property, and equipment

The amount of investment that a company requires is always dependent on the industry it is located. Companies in industries such as telecommunication, oil, public utilities industries, and manufacturing are always highly demanding for capital. It is important to note that capital expenditure (CAPEX) is NOT the same as operating expenses (OPEX). The later refers to the short-term costs needed to meet the current operating expenses for running a business. OPEX, unlike CAPEX, can be fully deducted from tax the same year that expenses occurred.

Capital Expenditure and Relative Value

Capital expenditure may also refer to the ratio of cash flow to capital expenditure. It shows a company's ability to purchase long-term assets using cash flow. 

When the ratio of cash flow to capital expenditure is less than 1, there is an insufficient cash flow to fund the acquisition of assets, and vice versa. Below is the formula for free cash flow: 

Free Cash Flow = Earnings Per Share (CapEx Depreciation) (1 Debt Ratio) - (Change in Net Working Capital) (1 Debt Ratio)OR:Free Cash Flow = Net Income - Net CapEx - Change in Net Working Capital + New Debt - Debt Repayment

Example of Revenue and Capital Expenditure

The following video demonstrates how to account for revenue expenditures and capital expenditures to maintain or improve operations.

Related Topics

• What are Plant Assets? – Financial Accounting

  • Property, Plant, and Equipment
• Depreciation, Depletion, and Amortization
  • What is the Straight-Line Method? – Financial Accounting
  • What is the Units of Production Method? – Financial Accounting
  • What is the Declining Balance Method? – Financial Accounting
  • Amortized Costs Definition
    
• How Reporting Depreciation for Tax is Unique? – Financial Accounting
• What happens when Depreciation Estimates Change? – Financial Accounting
• What are Capital Expenditures? – Financial Accounting
• How to Dispose of Plant Assets? – Financial Accounting