Hello, dear readers of the TechyAdjectives! In today’s article, we will talk about capital costs or capex for short ( CapEx ). You will learn what capital costs are, get acquainted with the formula and their calculation. We will also talk about the difference between CapEx and OpEx, and give examples of capital costs. Read about all this further in the article.
What is capital expenditure (CapEx)?
Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as real estate, factories, buildings, technology, or equipment. CapEx is often used for new projects or company investments .
Capital expenditures for property, plant and equipment may include repairs to a roof, purchase of equipment, or construction of a new plant. This type of financial expense is made by companies to expand their operations or add some economic benefit to an operation.
Formula and calculation of capital costs
CapEx = Δ PP&E + Current depreciation
where:
CapEx = Capital expenditure
Δ PP&E = Changes in fixed assets
What can CapEx tell you?
CapEx can tell you how much a company is investing in existing and new fixed assets to maintain or grow the business. In other words, CapEx is any type of expense that a company capitalizes or shows on its balance sheet as an investment , and not on the income statement as an expense. The capitalization of an asset requires the company to allocate the cost of the expense over the useful life of the asset .
The amount of capital expenditure a company is likely to have depends on the industry. Some of the most capital-intensive industries have the highest levels of capital expenditure, including oil exploration and production , telecommunications, manufacturing, and utilities.
CapEx can be found in cash flow from investing activities on a company’s cash flow statement. Different companies allocate capital expenditures differently, and an analyst or investor might see them listed as capital expenditures, purchases of fixed assets and equipment (fixed assets), or acquisition costs.
You can also calculate capital costs using data from the income statement and balance sheet of the company . In the income statement, find the amount of depreciation for the current period. In the balance sheet, find the itemized balance of fixed assets for the current period.
Find the balance sheet of the company’s fixed assets for the previous period and take the difference between them to get the change in the balance sheet of the company’s fixed assets. Add the change in fixed assets to the depreciation expense for the current period to get the company’s capital expenditure for the current period.
Difference Between Capital Expenditures and Operating Expenses (OpEx)
Capital costs should not be confused with operating expenses (OpEx). Operating expenses are short-term expenses required to cover the ongoing operating costs of running a business. Unlike capital expenditures, operating expenses can be fully deducted from company taxes in the same year in which they are incurred.
For accounting purposes, capital expenditure is considered capital expenditure when the asset is a newly acquired capital asset or an investment that has a life of more than one year or improves the useful life of an existing capital asset. However, if the expense is related to maintaining the asset in its current condition, such as repairs, the cost is usually deductible in full in the year the expense is incurred.
Example of using capital costs
In addition to analyzing a company’s investment in its fixed assets, CapEx is used in several ratios to analyze a company. The cash flow to capital expenditure ratio (CF-to-CapEx) refers to a company’s ability to acquire long-term assets using free cash flow. The CF/CapEx ratio often changes as businesses go through cycles of high and low capital expenditures.
A ratio greater than 1 may mean that the company’s activities generate the cash needed to finance the acquisition of assets . On the other hand, a low ratio may indicate that the company has problems with cash flow and, therefore, with the purchase of fixed assets. A company with a ratio less than one may need to borrow money to finance the purchase of fixed assets.
For example, Ford Motor Company in the fiscal year ending 2016 had a capital expenditure of $7.46 billion compared to Medtronic, which purchased $1.25 billion of personal protective equipment in the same fiscal year. CF-to-CapEx is calculated as follows:
CF/CapEx = Cash flow from operations / Capital expenditure
Where:
CF/CapEx = Ratio of cash flows to capital expenditures
Using this formula, the ratio of CF to CapEx for Ford Motor Company is as follows:
$14.51 billion / $7.46 billion = 1.94
CF-to-CapEx for Medtronic looks like this:
$6.88 billion / $1.25 billion = 5.49
It is important to note that this is an industry-specific ratio and should only be compared with a ratio obtained from another company that has similar capital expenditure requirements.
Capital expenditures are also used in the calculation of free cash flow to equity (FCFE). FCFE is the amount of cash available to shareholders. FCFE formula:
FCFE = EP – (CE – D) × (1 – DR) – ∆С × (1 – DR)
where:
FCFE = Free cash flow to equity
EP = Earnings per share
CE = Capital expenditure
D = Depreciation
DR = Debt ratio
ΔC = change in net working capital
Or alternatively, it can be calculated as:
FCFE = NI – NCE – ∆C + ND – DR
where:
NI – Net Income
NCE – Net Capital Expenditure
ND – New Debt
DR – Debt Repayment
*Hint: The higher the firm’s capital costs, the lower the FCFE.
Popular questions about capital expenditures
What is capital cost?
Capital expenditures (CapEx) are investments that companies make to grow or maintain their business operations. Unlike operating expenses, which are constantly recurring year after year, capital expenditures are less predictable. For example, a company that buys expensive new equipment will account for that investment as a capital expense. Accordingly, the cost of equipment will be depreciated over its useful life.
Are capital expenditures taxable?
Capital expenditures are not directly tax deductible. However, they can indirectly reduce company taxes through the depreciation they generate. For example, if a company buys $1 million worth of equipment with a useful life of 10 years, it might include $100,000 of depreciation charges every year for 10 years. This depreciation will reduce the company’s pre-tax earnings by $100,000 per year, thus lowering their income tax.
What is the difference between capital expenditure (CapEx) and operating expenditure (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 utilities. Capital expenditures, on the other hand, occur much less frequently and with less regularity. Operating expenses are charged to the income statement and are completely tax-free, while capital expenditures only deduct taxes from the depreciation they generate.
Summary
- Capital expenditures (CapEx) are payments for goods or services that are recognized—or capitalized—on the balance sheet , rather than expensed on the income statement.
- Capital expenditures are important for companies to maintain existing property and equipment, as well as invest in new technology and other growth assets .
- If an item has a useful life of less than one year, it should be expensed in the income statement and not capitalized (i.e. it cannot be treated as a CapEx).
And that’s all about capital expenditures (capex) today. I hope the article was useful to you. Share the article on social networks and instant messengers and bookmark the site. Good luck and see you on the pages of the TechyAdjectives!
