Capital expenditure (CapEx)

Capital expenditure (CapEx) refers to the funds a company spends on acquiring, upgrading, or maintaining physical and intangible assets. Unlike operating expenses (OpEx), which cover day-to-day operational costs, CapEx is related to long-term investments that will contribute to the company's growth and efficiency over time. These assets can include property, buildings, machinery, vehicles, technology, intellectual property, and even acquisitions.

CapEx is a crucial part of a business's strategy for expansion, competitiveness, and sustainability. The goal of these expenditures is typically to either expand operational capacity, replace outdated or worn-out equipment, or invest in new technologies that can offer a competitive edge.

Key takeaways

Long-term investments

CapEx involves significant investments with a long-term horizon, meaning the benefits from these expenditures will span several years, even decades.

Capitalisation

Unlike operating expenses, which are immediately expensed on the income statement, CapEx is capitalised. This means the expenditure is recorded as an asset on the balance sheet and is depreciated over its useful life.

Depreciation

Depreciation helps spread the asset's cost over several years, impacting both the balance sheet and the income statement.

Influence on financial health

Properly managing CapEx is essential for a company's financial health, as it directly impacts cash flow, the balance sheet, and profitability. Mismanagement can result in poor financial positioning and hinder growth opportunities.

CapEx can be categorised into three main types based on its purpose and objective:

Expansion CapEx:

Objective: To expand a company's capacity to produce goods or services, often by entering new markets or increasing production capacity.

Examples: Building new manufacturing plants, purchasing additional equipment, or opening new offices in different regions.

Maintenance CapEx:

Objective: To maintain or replace existing assets to ensure smooth, ongoing operations. These are expenditures to keep current assets functioning effectively.

Examples: Replacing ageing machinery, repairing facilities, or upgrading existing systems to keep them up to date.

Growth CapEx:

Objective: To invest in innovative technologies, systems, or capabilities that will drive future business growth, including advancements that make the company more competitive in the long term.

Examples: Investing in research and development (R&D), purchasing cutting-edge software or technology, or acquiring patents and intellectual property.

The capital expenditure process:

Identifying needs and opportunities

This stage involves evaluating the company's needs, such as the need for expansion, upgrading existing assets, or investing in new technologies. It requires cross-functional collaboration between departments like finance, operations, and strategic planning.

Budgeting and planning

After identifying needs, the next step is to create a budget. This involves estimating the costs of the proposed expenditures and determining how these investments fit into the company’s long-term financial plan. Budgeting also involves assessing potential returns on investment (ROI) and the impact on the company’s overall financial position.

Approval process

For significant CapEx investments, approval typically goes through a formal process, often involving senior management or a board of directors. The goal is to ensure that the investment aligns with the company’s strategic objectives and has sound financial backing

Implementation

Once approved, the company proceeds with the implementation phase. This may involve contracting with vendors, acquiring assets, or hiring teams to carry out the required work. The implementation phase requires strict project management to ensure that costs remain within budget and timelines are adhered to.

Frequently asked questions about Capital expenditure (CapEx)

1) How does CapEx differ from OpEx?

CapEx involves long-term investments in assets, while OpEx covers day-to-day operational costs. CapEx is capitalised and depreciated, while OpEx is expensed immediately.

2) Can software be considered CapEx?

Yes, if the software is expected to provide benefits for more than one year and meets certain criteria, it can be treated as CapEx.

3) How do companies decide on CapEx investments?

Companies use various financial analysis techniques, such as Net Present Value (NPV), Internal Rate of Return (IRR), and payback period to evaluate potential CapEx investments.