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 (if the useful life of the roof is extended), 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 future economic benefit to the operation.
- Capital expenditures are payments made for goods or services that are recorded or capitalized on a company's balance sheet instead of expensed on the income statement.
- Spending is important for companies to maintain existing property and equipment, and to 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, which means it isn't considered CapEx.
- Unlike CapEx, operating expenses (OpEx) are shorter-term expenses used for the day-to-day operations of a business.
- Examples of CapEx include the purchase of land, vehicles, buildings, or heavy machinery.
Capital Expenditures (CAPEX)
Understanding Capital Expenditures (CapEx)
CapEx can tell you how much a company invests in existing and new fixed assets to maintain or grow its 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 depends on the industry. Some of the most capital-intensive industries have the highest levels of capital expenditures, including oil exploration and production, telecommunications, 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 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.
Types of CapEx
Many different types of assets can attribute long-term value to a company. Therefore, there are several types of purchases that may be considered CapEx.
- Buildings may be used for office space, manufacturing of goods, storage of inventory, or other purposes.
- Land may be used for further development. Accounting treatment may different for land specifically held as a speculative long-term investment.
- Equipment and machinery may be used to manufacture goods and convert raw materials into final products for sale.
- Computers or servers may be used to support the operational aspects of a company including the logistics, reporting, and communication of operations. Software may also be treated as CapEx in certain circumstances.
- Furniture may be used to furnish an office building to make the space usable by staff and customers.
- Vehicles may be used to transport goods, pick up clients, or used by staff for business purposes.
- Patents may hold long-term value should the right to own an idea come to fruition through product development.
Formula and Calculation of CapEx
CapEx=ΔPP&E+Current Depreciationwhere:CapEx=Capital expendituresΔPP&E=Change in property, plant, and equipment
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.
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.
CapEx vs. 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.
Examples of CapEx
As part of its 2021 fiscal year end financial statements, Apple, Inc. reported total assets of $351 billion. Of this, it recorded $39.44 billion of property plant and equipment, net of accumulated depreciation.
These balances are dictated by Generally Accepted Accounting Principles (GAAP). The rules, treatment, and policies a company must follow when accounting for CapEx usually mirror Apple's treatment below.
Apple's balance sheet aggregates all property, plant, and equipment into a single line. However, more information on property, plant, and equipment is often required to be reported within the notes to the financial statements. In this case, this supplementary information explains that Apple has gross PPE of $109 billion, with almost $79 billion made up of machinery, equipment, and internal-use software.
The notes also explain how the property, plant, and equipment balance is reduced by accumulated depreciation balance. In this example, Apple has utilized $70.3 billion of the $109.7 billion of CapEx. The book value of this category of CapEx is valued at $39.4 billion.
Example of How to Use CapEx
Here's a hypothetical example to show how CapEx works. Let's say ABC Company had $7.46 billion in capital expenditures for the fiscal year compared to XYZ Corporation, which purchased PP&E worth $1.25 billion for the same fiscal year. The cash flow from operations for ABC Company and XYZ Corporation for the fiscal year was $14.51 billion and $6.88 billion respectively.
CF-to-CapEx is calculated as follows:
CF/CapEx=CapExCash Flow from Operationswhere:CF/CapEx=Cash flow to capital expenditure ratio
Using this formula, ABC's CF-to-CapEx is as follows:
$7.46 Billion$14.51 Billion=1.94
XYZ'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.
What Type of Investment Are CapEx?
CapEx 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.
Is CapEx 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 CapEx and OpEx?
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.
What Does CapEx Mean?
CapEx is an abbreviated term for capital expenditures, major purchases that are usually capitalized on a company's balance sheet instead of being expensed.
What Is an Example of CapEx?
When a company acquires a vehicle to add to its fleet, the purchase is often capitalized and treated as CapEx. The cost of the vehicle is depreciated over its useful life, and the acquisition is initially recorded to the company's balance sheet.
This is treated differently than OpEx such as the cost to fill up the vehicle's gas tank. The tank of gas has a much shorter useful life to the company, so it is expensed immediately and treated as OpEx.