What Are Capital Expenditures (CapEx)?
Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. CapEx is often used to undertake new projects or investments by a company. Making capital expenditures on fixed assets can include repairing a roof, purchasing a piece of equipment, or building a new factory. This type of financial outlay is made by companies to increase the scope of their operations or add some economic benefit to the operation.
Capital Expenditures (CAPEX)
Formula and Calculation of CapEx
CapEx=ΔPP&E+Current Depreciationwhere:CapEx=Capital expendituresΔPP&E=Change in property, plant, and equipment
- Capital expenditure (CapEx) is a payment for goods or services recorded—or capitalized—on the balance sheet instead of expensed on the income statement.
- CapEx spending is important for companies to maintain existing property and equipment, and invest in new technology and other assets for growth.
- If an item has a useful life of less than one year, it must be expensed on the income statement rather than capitalized (i.e., cannot be considered CapEx).
What CapEx Can Tell You
CapEx can tell you how much a company is investing in existing and new fixed assets to maintain or grow the business. Put differently, CapEx is any type of expense that a company capitalizes, or shows on its balance sheet as an investment, rather than on its income statement as an expenditure. Capitalizing an asset requires the company to spread the cost of the expenditure over the useful life of the asset.
The amount of capital expenditures a company is likely to have is dependent on the industry. Some of the most capital-intensive industries have the highest levels of capital expenditures including oil exploration and production, telecommunication, manufacturing, and utility industries.
CapEx can be found in the cash flow from investing activities in a company's cash flow statement. Different companies highlight CapEx in a number of ways, and an analyst or investor may see it listed as capital spending, purchases of property, plant, and equipment (PP&E), or acquisition expense.
You can also calculate capital expenditures by using data from a company's income statement and balance sheet. On the income statement, find the amount of depreciation expense recorded for the current period. On the balance sheet, locate the current period's property, plant, and equipment (PP&E) line-item balance.
Locate the company's prior-period PP&E balance, and take the difference between the two to find the change in the company's PP&E balance. Add the change in PP&E to the current-period depreciation expense to arrive at the company's current-period CapEx spending.
The Difference Between CapEx and Operating Expenses (OpEx)
Capital expenditure should not be confused with operating expenses (OpEx). Operating expenses are shorter-term expenses required to meet the ongoing operational costs of running a business. Unlike capital expenditures, operating expenses can be fully deducted from the company's taxes in the same year in which the expenses occur.
In terms of accounting, an expense is considered to be CapEx when the asset is a newly purchased capital asset or an investment that has a life of more than one year, or which improves the useful life of an existing capital asset. If, however, the expense is one that maintains the asset at its current condition, such as a repair, the cost is typically deducted fully in the year the expense is incurred.
Example of How to Use Capital Expenditures
Aside from analyzing a company's investment in its fixed assets, the CapEx metric is used in several ratios for company analysis. The cash-flow-to-capital-expenditures (CF-to-CapEx) ratio relates to a company's ability to acquire long term assets using free cash flow. The CF-to-CapEx ratio will often fluctuate as businesses go through cycles of large and small capital expenditures.
A ratio greater than 1 could mean that the company's operations are generating the cash needed to fund its asset acquisitions. On the other hand, a low ratio may indicate that the company is having issues with cash inflows and, hence, its purchase of capital assets. A company with a ratio of less than one may need to borrow money to fund its purchase of capital assets.
For example, Ford Motor Company, for the fiscal year ended 2016, had $7.46 billion in capital expenditures, compared to Medtronic which purchased PPE worth $1.25 billion for the same fiscal year. CF-to-CapEx is calculated as follows:
CF/CapEx=CapExCash Flow from Operationswhere:CF/CapEx=Cash flow to capital expenditure ratio
Using this formula, Ford Motor Company's CF-to-CapEx is as follows:
$7.46 Billion$14.51 Billion=1.94
Medtronic's CF-to-CapEx is as follows:
$1.25 Billion$6.88 Billion=5.49
It is important to note that this is an industry-specific ratio and should only be compared to a ratio derived from another company that has similar CapEx requirements.
Capital expenditures are also used in calculating free cash flow to equity (FCFE). FCFE is the amount of cash available to equity shareholders. The formula FCFE is:
FCFE=EP−(CE−D)×(1−DR)−ΔC×(1−DR)where:FCFE=Free cash flow to equityEP=Earnings per shareCE=CapExD=DepreciationDR=Debt ratioΔC=ΔNet capital, change in net working capital
Or, alternatively, it can be calculated as:
FCFE=NI−NCE−ΔC+ND−DRwhere:NI=Net incomeNCE=Net CapExND=New debtDR=Debt repayment
The greater the CapEx for a firm, the lower the FCFE.
Frequently Asked Questions
What are capital expenditures?
Capital expenditures are the investments that companies make to grow or maintain their business operations. Unlike operating expenses, which recur consistently from year to year, capital expenditures are less predictable. For example, a company that buys expensive new equipment would account for that investment as a capital expenditure. Accordingly, it would depreciate the cost of the equipment over the course of its useful life.
Are capital expenditures tax deductible?
Capital expenditures are not directly tax deductible. However, they can reduce a company’s taxes indirectly by way of the depreciation that they generate. For example, if a company purchases a $1 million piece of equipment that has a useful life of 10 years, it could include $100,000 of depreciation expense each year for 10 years. This depreciation would reduce the company’s pre-tax income by $100,000 per year, thereby reducing their income taxes.
What is the difference between capital expenditures and operating expenses?
The key difference between capital expenditures and operating expenses is that operating expenses recur on a regular and predictable basis, such as in the case of rent, wages, and utility costs. Capital expenses, on the other hand, occur much less frequently and with less regularity. Operating expenses are shown on the income statement and are fully tax-deductible, whereas capital expenditures only reduce taxes through the depreciation that they generate.