Capital Expenditure (CapEx)Defined along with Formula & How to Calculate
What is Capital Expenditure (CapEx)
Capital expenditures are the money a business uses to purchase, maintain, or improve its long-term assets.
These expenditures may include purchasing land, repairing equipment, or updating facilities.
Businesses usually make capital expenditures in order to help their business grow or improve its operations.
Capital expenditures are a type of investment that businesses can make in order to promote growth in their business or to help maintain their current long-term assets.
These expenditures are different than operating expenses in that, unlike operating expenses, they do not occur on a regular basis, nor are they as predictable.
An example of capital expenditure would be a new building that a company purchases as part of an expansion.
The company would treat this new building as a capital expenditure.
Thus, the cost of the building would be depreciated over the useful life of the building.
Capital Expenditures Formula
CF/CapEx = Cash Flow from Operations / CapEx
CapEx = Capital expenditures = Change in property, plant, and equipment
Learning from Capital Expenditures
An investor can learn a lot about a business from capital expenditures.
They can learn about how much a business is investing in new assets as well as its existing assets so as to maintain or expand the company.
Capital expenditures or expenditures that a business capitalizes are not the same as operating expenses; these expenses are recorded on the balance sheet as an investment instead of being recorded as an expenditure on the income statement.
When a company capitalizes an asset, it expenses the cost of the asset over the asset’s useful life.
Different industries tend to have different levels of capital expenditures.
Industries such as transportation, automobile manufacturing, and telecommunications tend to have large capital expenditures.
A company’s capital expenditures can be located in a company’s cash flow statement in cash flow from investing activities.
This could be listed in different ways, such as purchases of property, plant, and equipment, capital spending, or acquisition expense.
It is also possible to compute a business’s capital expenditures by using the information on its balance sheet and income statement.
The balance sheet will have the business’s current property plant and equipment balance (PP&E balance).
Whereas, the current period’s depreciation expense can be found on the business’s income statement.
Once you find the business’s PP&E balance from the previous period, you will want to find the difference between this and the current PP&E balance, which will give you the change in the business’s PP&E balance.
Next, add this number to the depreciation expense for the current period, and this will give you the business’s capital expenditure spending for the current period.
Using Capital Expenditures
There are many uses for capital expenditures.
One of the most common uses of this number is to analyze the investments a company makes in fixed assets.
However, the capital expenditure metric is also used in a number of ratios for business analysis.
One of these ratios is the cash flow to capital expenditures ratio (CF-to-CapEx).
This ratio looks at a business’s ability to purchase assets with its free cash flow.
If a business has a CF-to-CapEx ratio that is greater than one, it may mean that the business is operating or providing enough cash for the business to purchase the assets it wants.
In contrast, a company with a low ratio may be having problems with its cash flow, thus leading to difficulty in acquiring capital assets.
In fact, if a business has a CF-to-CapEx ratio that is below one, the business might find it necessary to borrow money in order to be able to buy capital assets.
As an example of this ratio, take a look at the Kraft Heinz Company, which had capital expenditures of $596 million in 2020.
The company’s cash flow to capital expenditure ratio was 8.34.
The formula to calculate this ratio is:
CF/CapEx = Cash Flow from Operations / CapEx.
CF/CapEx = $4.93 billion/$596 million
CF/CapEx = 8.34
General Mills had capital expenditures of $530.8 million in 2020. Its cash flow to capital expenditure ratio was 5.61.
CF/CapEx = $2.98 billion/$530.8 million
CF/CapEx = 5.61
It is essential to remember that the cash flow to capital expenditure ratio is industry-specific.
Therefore a business should only compare this ratio to other businesses with similar capital expenditure requirements.
Businesses can also use capital expenditures when computing free cash flow to equity.
Free cash flow to equity (FCFE) is a ratio that shows the amount of cash that is currently available to equity stockholders.
The formula for free cash flow to equity is:
FCFE = Net Income + Depreciation and Amortization + Changes in Working Capital + Capital Expenditures + Net Borrowings
The greater a business’s capital expenditures are, the lower its FCFE will be.
Can Capital Expenditures Be Deducted from Taxes?
Businesses cannot directly deduct the amount of capital expenditures on their taxes.
Instead, capital expenditures are deducted indirectly through the depreciation of these assets.
An example of this would be a business that buys a copy machine for $7,000 with a useful life of seven years.
The business could claim depreciation expense of $1,000 a year for seven years.
The $1,000 depreciation would lower the pre-tax income of the business by $1,000, thus lowering their income taxes.
CapEx vs. Operating Expenses (OpEx)
Capital expenditures are not the same as operating expenses.
Operating expenses are those expenses that are necessary to continue the operations of the business.
These are typically short-term expenses such as office supplies or utilities.
Operating expenses are fully deductible and are deducted from the business’s taxes in the year in which the expenses are incurred.
For accounting purposes, a capital expenditure is a capital asset that the company has recently purchased, an investment the company has made that will extend for over a year, or an investment that will improve the useful life of a capital asset the business currently owns.
In contrast, the cost of maintaining an asset in its current condition, including repairs, is generally deducted in the same year in which the expense occurs.
The most important difference between operating expenses and capital expenditures is the fact that operating expenses are a regular occurrence.
Operating expenses are things such as wages, insurance, or office supplies.
Capital expenditures do not occur as frequently as operating expenses and are not near as predictable.
Another important difference between operating expenses and capital expenditures is the way in which these items are deducted from taxes.
Operating expenses appear on the income statement, and they can be fully deducted when filing taxes.
In contrast, capital expenditures can only be deducted for the amount of depreciation.
- Capital expenditures are funds that a business uses to purchase tangible assets that will be used for more than a year or to maintain or improve its fixed assets.
- Capital expenditures are recorded as an investment on the business’s balance sheet.
- If an asset has a useful life of under one year, it must be recorded as an expenditure on the business’s income statement instead of being capitalized.
- Capital expenditures are an important way for businesses to improve their facilities as well as their operating efficiency.
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Cornell Law School "Capital Expenditure" Page 1 . January 31, 2022
Purdue University "CORPORATE CAPITAL EXPENDITURE DECISIONS AND THE MARKET VALUE OF THE FIRM* " White paper. January 31, 2022
IRS.gov "Section 263.–Capital Expenditures" Part I - Section 263. January 31, 2022