Capital expenditure (CAPEX): Definition, example, formula

What is capital expenditure?

Capital expenditure refers to the funds that are spent by a company to acquire, upgrade, or maintain their long-term assets.

CAPEX is considered an investment in a company's long-term growth. Unlike operating expenses (OPEX), which cover day-to-day operational costs, CAPEX usually focuses on acquiring or upgrading assets that benefit a business over a certain period of time.

Examples of capital expenditures

Capital expenditures can include a wide range of different investments. Here are some examples of common capital expenditures:

• Real Estate purchases - A business buying a new office building to expand operations.
• Equipment upgrades - A hospital investing in advanced medical equipment to enhance patient care.
• Renovating existing assets - A retail chain refurbishing its stores to improve customer experience.
• Technology investments - A software company purchasing new servers to handle their increased data traffic.

Importance of CAPEX in financial planning

Capital expenditure plays a very important role in ensuring a company’s long-term growth and sustainability. It gives businesses the ability to maintain their competitive edge by upgrading their outdated equipment, acquiring new technology, or expanding their physical footprint.

Companies need to carefully balance their CAPEX investments with their cash flow and financial health in order to avoid overextending their resources.

Types of capital expenditures

There are a few different forms of capital expenditures, depending on the needs and goals of a business. They are usually broken down into two main categories: tangible and intangible assets.

Tangible assets

Tangible capital expenditures are investments in physical assets such as buildings, machinery, vehicles, and land. These are the tangible resources that a business relies on to produce goods, deliver services, or expand operations. For example, a manufacturing company might spend on new production lines to increase capacity or upgrade older equipment in order to improve efficiency. A retail business could invest in constructing a new store or renovating an existing one to attract more customers. Tangible CAPEX can help with daily operations and also acts as a foundation for long-term growth and gives the company a competitive advantage.

Intangible assets

Intangible capital expenditures cover non-physical assets like patents, copyrights, trademarks, and software licenses. These investments are important for businesses that are working in industries that are driven by innovation, creativity, or intellectual property. For example, a tech company might purchase software licenses to enhance its capabilities or it could acquire patents to secure a competitive edge in the market. Intangible CAPEX often represents a significant portion of spending for businesses that want to protect their intellectual assets or develop new products and services. These investments can help out a company’s long-term strategy by strengthening its intellectual property portfolio and allowing it to adapt to changing market demands.

Maintenance CAPEX vs. growth CAPEX

Capital expenditures can also be categorized by their purpose, with the two main types being maintenance CAPEX and growth CAPEX. Maintenance CAPEX refers to expenditures that are aimed at maintaining or repairing existing assets to ensure they continue functioning properly. For example, replacing a broken machine or upgrading any outdated equipment to meet safety standards will fall under maintenance CAPEX.

On the other hand, growth CAPEX is the investments that are made to expand a company’s operations or to help enhance its profitability. These expenditures are forward-looking and are focused on increasing production capacity, entering new markets, or improving the company’s overall efficiency. For example, purchasing additional delivery vehicles to cater to a larger customer base or building a new manufacturing facility to meet rising demand would be considered growth CAPEX.

Recording CAPEX in financial statements

It's also very important to have a solid understanding of how to record CAPEX in different financial statements in order for businesses to accurately track their long-term investments.

The balance sheet

Capital expenditures are recorded as long-term assets on the balance sheet under property, plant, and equipment (PP&E). These assets are the tangible and intangible resources a business owns and relies upon in order to generate revenue over multiple years. Instead of being expensed immediately, CAPEX is treated as an investment that provides value over time. For example, when a company purchases a new factory, its cost is added to the balance sheet, increasing the value of PP&E. Over the asset’s useful life, its value is slowly reclassified as depreciation expense, showing its wear and tear or because it becomes obsolete.

The cash flow statement

In the cash flow statement, CAPEX is categorized under investing activities, which shows the company’s spending on long-term investments. These expenditures are recorded as cash outflows, showing the funds that are used to acquire or upgrade assets. For example, a company purchasing new machinery for $100,000 will show this amount as a cash outflow under investing activities. This section of the financial statement gives stakeholders a much clearer view of how the company allocates resources for future growth and asset management.

The income statement

It’s important to note that while CAPEX itself does not appear directly on the income statement, its impact is reflected over time through depreciation expenses. Depreciation gives businesses the ability to spread the cost of an asset over its useful life, aligning the expense with the revenue generated by the asset. For example, if a company invests in a $50,000 piece of equipment with a useful life of five years, it will record a $10,000 annual depreciation expense on the income statement. This gradual expense reduces the asset’s book value on the balance sheet while also giving a more accurate representation of financial performance over time.

CAPEX formula and calculation

Calculating CAPEX is simple. To do so, businesses use information from their financial statements, specifically the balance sheet and income statement. The CAPEX formula is:

CAPEX = Change in PP&E + Current Depreciation

Change in PP&E - This is the difference in property, plant, and equipment values between the start and end of a fiscal year.

Current depreciation - This is the depreciation expense for the current period, found on the income statement.

Example calculation

Let’s say a company starts the fiscal year with $500,000 in PP&E and ends with $600,000. The current depreciation expense is $50,000. Using the formula:

CAPEX = ($600,000 - $500,000) + $50,000

CAPEX = $100,000 + $50,000 = $150,000

This shows that the company spent $150,000 on capital expenditures during the fiscal year.

CAPEX vs. OPEX

Capital expenditures (CAPEX) and operating expenses (OPEX) are two different and very distinct categories of business expenses that have different purposes. CAPEX are the investments in long-term assets that provide value over several years, such as purchasing machinery, constructing facilities, or upgrading equipment. These expenditures are recorded as assets on the balance sheet and gradually expensed over time through depreciation.

On the other hand, OPEX covers the costs associated with day-to-day business operations. Some of the most common examples include salaries, utilities, office supplies, and rent. Unlike CAPEX, OPEX is fully expensed in the income statement during the current period, showing its immediate impact on the company's financial performance.

The role of depreciation in CAPEX

Depreciation plays a very big role in accounting for CAPEX. It spreads the initial cost of a long-term asset over its useful life, aligning the expenses with the revenue that is generated by the asset. Here are some of the most common methods of depreciation:

• Straight-line depreciation - This method spreads the asset’s cost evenly over its useful life.
• Declining balance depreciation - This method has a higher depreciation expense in the early years, but it decreases over time.
• Units of production depreciation - This method is based on the asset’s usage or output rather than time.

The total depreciation over the asset's useful life is the same, regardless of the depreciation method you choose. The only difference is in the timing of the depreciation expense each year.

Forecasting CAPEX for financial planning

Businesses use CAPEX forecasting to plan for future investments and ensure adequate funding. Forecasting involves analyzing historical data, assessing current business needs, and projecting future growth opportunities. Here are some of the most common metrics that are used to evaluate CAPEX investments for financial planning:

• Return on investment (ROI) - Measures the profitability of a CAPEX investment relative to its cost.
• Payback period - The time it takes for an investment to generate enough cash inflows to cover its initial costs.
• Net present value (NPV) - Evaluates the value of future cash inflows from an investment compared to its current cost.

Challenges in managing CAPEX

While managing capital expenditures is straightforward, there are a few challenges that businesses need to be aware of in order to properly balance their immediate needs with their long-term goals.

Balancing short-term and long-term goals - Businesses must balance the immediate cash outflows associated with CAPEX against the long-term benefits. Overextending on CAPEX can strain cash flow and limit day-to-day operations.

Monitoring existing assets - Regularly assessing the performance and condition of existing assets ensures that CAPEX investments are both completely strategic and necessary. For example, maintaining a fleet of vehicles might require balancing the costs of repairs versus purchasing new ones.

Industry-specific considerations - Different industries have unique CAPEX needs. For instance, real estate companies focus heavily on property acquisitions, while tech companies prioritize software and server upgrades.

Capital expenditures and business growth

Capital expenditures are necessary to sustain and grow a business. They allow companies to invest in assets that drive their efficiency, profitability, and long-term value. For businesses that want to streamline their financial processes and optimize their spending, Ramp automates expense management, enhances financial reporting, and provides actionable insights. That makes it easier to manage both CAPEX and OPEX properly. Discover how Ramp’s tools can help with smarter financial planning and help your business achieve long-term, sustainable growth.