## What Are Capital Expenditures – CapEx?

Capital expenditures, commonly known as CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, an industrial plant, technology, or equipment.

CapEx is often used to undertake new projects or investments by the firm. Making capital expenditures on fixed assets can include everything from repairing a roof to building, to purchasing a piece of equipment, to building a brand new factory. This type of financial outlay is also made by companies to maintain or increase the scope of their operations.

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.

## The Formula for CapEx Is

﻿\begin{aligned} &\text{CapEx} = \Delta \text{PP\&E} + \text{Current Depreciation} \\ &\textbf{where:}\\ &\text{CapEx} = \text{Capital expenditures} \\ &\Delta \text{PP\&E} = \text{Change in property, plant, and equipment} \\ \end{aligned}﻿

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## How to Calculate CapEx

If you have access to a company's cash flow statement, no calculation is needed. Look for the company's capital expenditures in the Cash Flows From Investing section of the company's cash flow statement.

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.

## What Does the CapEx Metric Tell You?

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 on the company's taxes in the same year in which the expenses occur.

CapEx can tell you how much a company is investing in existing and new fixed assets to maintain or grow the business. In terms of accounting, an expense is considered to be a capital expenditure 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. Expenses for items such as equipment that have a useful life of less than one year, according to IRS guidelines, must be expensed on the income statement.

If an expense is a capital expenditure, it needs to be capitalized. This requires the company to spread the cost of the expenditure (the fixed cost) over the useful life of the asset. If, however, the expense is one that maintains the asset at its current condition, the cost is typically deducted fully in the year the expense is incurred.

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), acquisition expense, etc. The amount of capital expenditures a company is likely to have depends on the industry it occupies.

Some of the most capital intensive industries have the highest levels of capital expenditures including oil exploration and production, telecommunication, manufacturing, and utility industries. 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.

### Key Takeaways

• A capital expenditure 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, plant & 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.

## 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-expenditure ratio, or CF/CapEX ratio, relates to a company's ability to acquire long term assets using free cash flow. The cash-flow-to-capital-expenditures 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.

CF to CapEx is calculated as follows:

﻿\begin{aligned} &\text{CF/CapEx} = \frac { \text{Cash Flow from Operations} }{ \text{CapEx} } \\ &\textbf{where:}\\ &\text{CF/CapEx} = \text{Cash flow to capital expenditure ratio} \\ \end{aligned}﻿

Using this formula, Ford Motor Company's CF/CapEx is as follows:

﻿\begin{aligned} &\frac { \14.51\ \text{Billion} }{ \7.46\ \text{Billion} } = 1.94 \\ \end{aligned}﻿

Medtronic's CF/CapEx is as follows:

﻿\begin{aligned} &\frac { \6.88\ \text{Billion} }{ \1.25\ \text{Billion} } = 5.49 \\ \end{aligned}﻿

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 expenditure can also be used in calculating free cash flow to equity (FCFE) to a firm with the following formula:

﻿\begin{aligned} &\text{FCFE} = \text{EP} - ( \text{CE} - \text{D} ) \times ( 1 - \text{DR} ) - \Delta \text{C} \times ( 1 - \text{DR} ) \\ &\textbf{where:}\\ &\text{FCFE} = \text{Free cash flow to equity} \\ &\text{EP} = \text{Earnings per share} \\ &\text{CE} = \text{CapEx} \\ &\text{D} = \text{Depreciation} \\ &\text{DR} = \text{Debt ratio} \\ &\Delta \text{C} = \Delta \text{Net capital, change in net working capital} \\ \end{aligned}﻿

Or, alternatively, it can be calculated as:

﻿\begin{aligned} &\text{FCFE} = \text{NI} - \text{NCE} - \Delta \text{C} + \text{ND} - \text{DR} \\ &\textbf{where:}\\ &\text{NI} = \text{Net income} \\ &\text{NCE} = \text{Net CapEx} \\ &\text{ND} = \text{New debt} \\ &\text{DR} = \text{Debt repayment} \\ \end{aligned}﻿

The greater the capital expenditure for a firm, the lower the free cash flow to equity.