Capital Expenditures vs. Operating Expenditures (Expenses): An Overview
In financial accounting capital expenditures (CapEx) and operating expenditures (expenses) (OPEX) are two categories of business expenses. However, there are distinct differences between the two, including their respective tax treatments.
- Capital expenditures comprise major purchases that will be used in the future.
- Operating expenditures (expenses) represent day-to-day costs that are necessary to keep a business running.
Capital expenditures consist of the funds that companies use to purchase major physical goods or services that the company will use for more than one year. A company might incur CapEx to increase or improve its fixed assets, for example.
Fixed assets are treated as noncurrent assets from an accounting standpoint, which means that they will not be consumed in the first year.
Capital expenditures can include:
- Plant and equipment purchases
- Building expansion and improvements
- Hardware purchases, such as computers
- Vehicles to transport goods
The type of industry in which a company operates largely determines the nature of its capital expenditures. The asset purchased can be a new item or something that improves the productive life of a previously purchased asset.
The capital expenditure is recorded as an asset on the balance sheet under the property, plant, and equipment (PP&E) section. However, it's also recorded on the cash flow statement under investing activities because it's a cash outlay for that accounting period.
Once the asset is being used, it is depreciated over time to spread the cost of the asset over its useful life. In other words, each year, a portion of the fixed asset is being used up. Depreciation represents the degree of wear and tear on a fixed asset; companies may deduct the amount of depreciation on their annual tax return. Capital expenditures are often depreciated over 5 to 10 years, but in the case of real estate, they may be depreciated over more than two decades.
Operating expenditures are the ordinary and necessary expenses (O&NE) that a company spends to operate its business each day.
Operating expenditures can include:
- Salaries and pension plan contributions
- Any expense that falls under selling, general, and administrative expense (SG&A) on the income statement
- Research and development (R&D)
- Property taxes
- Business travel
Because operating expenses make up the bulk of a company's ongoing costs, management typically looks for ways to reduce its OPEX without causing a critical drop in quality or production output. In contrast to CapEx, operating expenses are fully tax-deductible in the year they are made.
- An item that normally would classify as a capital expenditure may be considered an operating expense if the company chooses to lease it instead of buying it.
- This can be an attractive accounting option if the company has limited cash flow and wants to be able to deduct the total cost of an item in a tax year.
Key Differences vs. CapEx and OPEX
Funds that fall under capital expenditures are for major purchases that will be used in the future. The life of these purchases extends beyond the current accounting period in which they were purchased. Because these costs can be recovered only over time through depreciation, companies usually prepare a capital expense budget apart from OPEX.
Operating expenses represent the day-to-day expenses necessary to run a business. Because these are short-term costs that are used up in the same accounting period in which they were purchased, it makes sense for them to have a separate budget.