Capex (Capital Expenditure)

What is Capital Expenditure?

Capex or Capital Expenditure is the expense of the company’s total purchases of assets during a given period determined by adding the net increase in plant, property, equipment, and depreciation expense during a fiscal year.

Understanding Capital Expenditure

In simple words, it refers to the financial outlay for buying, maintaining, or improving the fixed assets base (such as plant, property, and equipment) of the company. The money spent is considered for the sole purpose of buying new fixed assets, repairing the existing fixed assets, or upgrading the existing capacity of the fixed assets. Capital expenditure is a major financial decision for a company, must be formally approved at an annual shareholders meetingShareholders MeetingShareholders Meeting means a meeting of the stockholders of the corporation wherein resolution are placed before the shareholders to discuss and approve the corporate matters and other matters required by the bylaws of the company.read more or a special meeting of the Board of Directors.

Capital expenditure examples includes:

A CAPEX offers the potential to reap benefits in the future as a part of long-term strategic goals. However, the biggest challenge associated with the decision of capital expenditure is that it cannot be undone in the future without incurring losses given the huge initial outlay. As such, wrong capital investment can be detrimental to a company’s growth. Nevertheless, it has to be incurred either in the form of a new setup or up-gradation of the existing setup to ensure that the company is operating with state-of-the-art technology. It is to be noted that if the capital expenditure incurred during the year is higher than the depreciation expense during the year, it indicates a company’s growing asset base. Otherwise, it is a shrinking asset-based company.

Capital Expenditure Accounting

Going by the general rules of Capex accounting, if the acquired property’s useful life is longer than the taxable year, then the cost must be capitalizedCost Must Be CapitalizedCapitalization cost is an expense to acquire an asset that the company will use for their business; such costs are recorded in the company's balance sheet at the year-end. These costs are not deducted from the revenue but are depreciated or amortized over time.read more. This cost is not charged to the profit and loss statement at once in the taxable year but is spread over the useful life of the asset in the form of amortization and depreciation.

#1 – Effect on Balance Sheet

The entire capital expenditure cost is capitalized on the asset side of the balance sheet. It increases the non-current assetThe Non-current AssetNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.read more base of the entity, while at the same time reducing the cash balance of the entity.

Capex on Balance Sheet

#2 – Effect on Income Statement

The capital expenditure costs are amortized or depreciated through profit and loss statement over the useful life of the asset.

ford-straight-line-method-of-depreciation

source: Ford SEC Filings

#3 – Effect on Cash Flow Statement

Since the reduction in the cash balance of the entity is reflected in the balance sheet as at the end of the taxable year, this financial outlay does get reflected in cash flow statement from investingCash Flow Statement From InvestingCash flow from investing activities refer to the money acquired or spent on the purchase or disposal of the fixed assets (both tangible and intangible) for the business purpose. For instance, the purchase of land and joint venture investment is cash outflow, while equipment sale is a cash inflow.read more activities section as capital spending, purchases of property, plant, and equipment (PPE), acquisition expense, etc.

Capex - Cash Flow Statement

Walmart Example

Shown below is the capital expenditure example of Walmart Inc. from its 2018 10-k SEC filings.

Walmart Inc example

Capex is Different from Other Expenses

Some industries are more capital-intensive, and some are less capital-intensive. The capital expenditures of an entity depending on the industry it operates in. Capital-intensive industries, like oil exploration and production, like telecommunication, like manufacturing, and utility industries, have the highest levels.

How to use of Capex?

#1 – CFO to Capex Ratio

Cash Flow to Capex

Cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more to Capex is a very important ratio used by Financial Analysts. It is as follows:

CapEx Formula

If the ratio is greater than 1, it could mean that the company’s operations are generating cash, sufficient to fund its asset acquisitions. On the other hand, if the ratio is less than 1, it could mean that the company may need to borrow money to fund its purchase of capital assets.

#2 – Calculating FCFF

Also, CapEx is used in calculating the Free Cash Flow for the Firm (FCFF)(FCFF)FCFF (Free cash flow to firm), or unleveled cash flow, is the cash remaining after depreciation, taxes, and other investment costs are paid from the revenue. It represents the amount of cash flow available to all the funding holders – debt holders, stockholders, preferred stockholders or bondholders.read more as follows:

CapEx example

Presented below is the Free Cash Flow to the Firm of Alibaba.Alibaba - FCFF Free Cash Flows

#3 – Calculating FCFE

Ans, CapEx is used in calculating the Free Cash Flow for the Equity HoldersFree Cash Flow For The Equity HoldersFCFE (Free Cash Flow to Equity) determines the remaining cash with the company's investors or equity shareholders after extending funds for debt repayment, interest payment and reinvestment. It is an indicator of the company's equity capital managementread more (FCFE) as follows:

CapEx example1

Below is the FCFE calculation of Alibaba.

Alibaba IPO FCFE Forecasts

Relevance and Use

Capital Expenditure Video

 

This article has been a guide to what is Capital Expenditure (Capex) and its meaning? Here we discuss Capital Expenditure accounting along with examples and analysis. You may learn more about accounting from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *