Capital Expenditure (Capex)

What is Capital Expenditure (Capex)?

Capital expenditure (CapEx) of a business is the total capital spent on buying, maintaining, and upgrading fixed assets. This includes both tangible and intangible assets like machinery, equipment, manufacturing plant, land, buildings, transportation, technology, patents, and licenses. 

Capex is determined by adding the net increase in manufacturing plants, property, equipment, and depreciation expenses within a fiscal year. Businesses rely on capital assets on a daily basis. Therefore, investing in them is crucial for the functioning and growth of the firm. Also, all these expenditures affect the balance sheet.

• Capital expenditure (CapEx) is the strategic investment of funds in the purchase, improvement, and maintenance of long-term assets. This is done to enhance the efficiency of business operations.
• Expenses on assets are considered CapEx only if the assets can be used for more than a year.
• Capex is calculated by subtracting an aggregate of the previous period's property, plant, and equipment from the current total. Then, the residual amount is added to the depreciation charges for the current period. The depreciation is charged on fixed assets and includes amortization costs.

Capital Expenditure Explained

CapEx is simply the money a company pours into the buying, upgrading, and maintaining of long-term assets. These investment decisions are critical to an organization due to hefty initial costs, irreversibility, and long-term effects. Some industries are more capital-intensive than others. Therefore, the CapEx of an entity depends on the type of industry. For instance, oil exploration and production have the highest CapEx levels. Similarly, telecommunication, manufacturing, and utility industries also require substantial investments. 

Capital expenditure is a significant financial decision. It must be formally approved at an annual shareholders' meeting or a board of directors meeting. To evaluate long-term investments and related cash flows, firms take a closer look at CapEx. In addition, investors, shareholders, lenders, and creditors also track the number of funds allocated to fixed assets.

Types of Capital Expenditure

CapEx is classified as follows.

#1 - CapEx on Tangible Assets

These are usually the physical, fixed, and non-consumable assets that have a useful life of more than one accounting period. It includes the following:

• Investment in land, property, or building along with its maintenance, renovation, and debt repayment.
• Acquisition of manufacturing plant, machinery, and equipment along with repairs, upgrades, and depreciation charges.
• Vehicle purchase for delivery and distribution of goods is another capital expenditure that involves maintenance, repair, and depreciation charges.
• Purchase and installation of computers, laptops, and peripheral devices along with maintenance costs.

#2 - CapEx on Intangible Assets

The value of cost incurred on the non-physical assets is realized in more than one fiscal year. These are also considered CapEx. It includes the following:

• Purchase and upgradation of software,
• Getting patents and copyrights for technology, products, and services,
• Goodwill paid by a company while taking over another firm,
• And license registration charges.

Capital Expenditure Accounting

If the acquired property's useful life is longer than the taxable year, then the cost must be capitalized. This cost is not charged to the profit and loss statement at once. Rather this cost is spread over an asset's useful life in the form of amortization and depreciation.

Given below is an example from Ford Motors that represents how CapEx affects the financial statements:

#1 – Effect on Balance Sheet

The entire capital expenditure cost is capitalized on the asset side of the balance sheet. Thus, it increases the non-current assets of the entity. Simultaneously, CapEx also reduces the cash balance.

The highlighted items in the asset section denote the capital expenditure.

#2 – Effect on Income Statement

The capital expenditure costs are amortized or depreciated through profit and loss statements over the asset's useful life.

#3 – Effect on Cash Flow Statement

The reduction in the cash balance of an entity is reflected in the balance sheet at the end of the taxable year. Therefore, this financial outlay does reflect in the cash flow statement. In addition, it is mentioned in the investing activities section that includes the purchase of property, plant, and equipment.

CapEx Formula

The capital expenditure can be calculated with the help of the following formula:

Here;

• ∆P, P&E is the change in property, plant, and equipment,
• The depreciation accounts for the current accounting period, including the amortization of intangible assets,
• P, P&E of current period comprises the total value of the property, plant, and equipment for the current accounting period; and
• P, P&E of the prior period comprises the total value of the property, plant, and equipment during the previous accounting period.

How to Calculate Capital Expenditure?

CapEx is calculated using the following steps.

1. Calculate the increased amount of property, plant, and equipment by deducting the previous period's total fixed assets from the current period's aggregate.
2. Using the income statement, find the total depreciation charged on fixed assets for the current period. Also, locate the amortization expense for intangible assets.
3. Now, add P, P & E changes to the depreciation expense of the current period to evaluate CapEx.

Example of Capital Expenditure

Consider the following CapEx example to understand practical applications better.

Walmart Inc.

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

• The above cash flow statement shows Walmart spending $10,051 million to buy property and equipment. This was the expenditure for one financial year.
• Walmart spent a lot for acquiring fixed assets. Therefore, in the income statement, it cannot be expensed all at once. Thus, this expenditure can be classified as a capital expenditure.
• More information about the exact nature can be found from the company's notes, located in financial filings.
• Often, a pattern is seen in a company’s spending. This could potentially reflect aggressive expansion.

Difference Between Capital Expenditure and Revenue Expenditures

CapEx focuses on long-term benefits. In contrast, the revenue expenditure or OpEx is the daily operations cost. This cost facilities conversion of inventory into finished goods.  

For Capital expenditure, physical assets can be depreciated throughout their useful life, and non-physical assets can be amortized. However, for revenue expenditure, the operating expenses have to be accounted for in the same accounting year.

Examples of revenue expenditure include rent, wages, salary, electricity bills, freight, and commission. Most capital expenditures are leveraged. In contrast, the operating expenses under revenue expenditure come from the company's working capital.

Relevance and Use

The application and relevance of CapEx in the business world are as follows.

• Computing CFO to CapEx Ratio: Cash Flow from Operations divided by CapEx is a vital ratio used by financial analysts. They ascertain if the cash generated from business operations is enough to fund capital expenditures. A ratio higher than one is considered feasible.
• Calculating Free Cash Flow for Firm (FCFF): Capital expenditure is also used in ascertaining the value of FCFF. The formula is as follows:

Free Cash Flow for Firm = EBIT (1 – Tax Rate) + Depreciation – Change in Net Working Capital – CapEx.

• Determining Free Cash Flow for Equity Holders (FCFE): The CapEx figure is put into the following formula.

Free Cash Flow for Equity Holders = Net Income + Depreciation – Change in Net Working Capital – CapEx + New Debt Raised – Debt Repayment.

• Aid Investment Decision-Making: The significant effect of CapEx on the short-term and long-term financial standing of an organization warrants making wise expenditure decisions.
• Attract Investors: Many companies maintain historical capital expenditure records to show the investors that the managers are investing effectively.
• Facilitate Capital Budgeting: All investments on capital items are executed after careful planning. These investments significantly impact cash flow. For analysis, companies take a closer look at previous years' CapEx and the availability of funds.

Frequently Asked Questions (FAQs)

Capital Expenditure Video

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This article has been a guide to what is Capital Expenditure and its Meaning. Here we explain Capex accounting, its types, and its uses. You may learn more about accounting from the following articles -

• FCF Formula
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• Capex vs. Opex
• Capital Expenditure Formula