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Capital expenditures (CAPEX) and operating expenses (OPEX) represent two basic categories of business expenses. They differ in the nature of the expenses, and in their respective treatments for tax purposes.

Capital Expenditures

Capital expenditures are the funds that a business uses to purchase major physical goods or services to expand the company's abilities to generate profits. These purchases can include hardware (such as printers or computers), vehicles to transport goods, or the purchase or construction of a new building. The type of industry a company is involved in largely determines the nature of its capital expenditures. The asset purchased may be a new asset or something that improves the productive life of a previously purchased asset.

If the asset's useful life extends more than a year, then the CAPEX is recorded as an asset in the balance sheet and is expensed using depreciation to spread the cost of the asset over its designated useful life as determined by tax regulations. Capital expenses are most often depreciated over a five to 10-year period, but may be depreciated over more than two decades in the case of real estate.

Operating Expenses

An operating expense results from the ongoing costs a company pays to run its basic business. In contrast to capital expenditures, operating expenses are fully tax-deductible in the year they are made. As operational expenses make up the bulk of a company's regular costs, management examines ways to lower operating expenses without causing a critical drop in quality or production output.

Sometimes an item that would ordinarily be obtained through capital expenditure can have its cost assigned to operating expenses if a company chooses to lease the item rather than purchase it. This can be a financially attractive option if the company has limited cash flow and wants to be able to deduct the total item cost for the year. Examples of operating expenses include research & development (R&D) expenses, pension plan contributions, property taxes, business travel, rent, and insurance costs.

Capital expenditures are major purchases, and because their costs can only be recovered over time through depreciation, companies ordinarily budget for these purchases separately from preparing an operational budget.

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