One of the most effective ways for companies to accelerate their growth and trajectory is by investing in or improving assets, resources, and IP to further strengthen their ability to operate efficiently at scale.
The process of businesses making strategic investments is known as capital expenditure, or CapEx. Capital expenditure is an incredibly common method used by larger businesses to take their commerce to the next level, and in many cases further elevate their market share. Investing in improving fixed assets such as machinery or an office building can go a long way in giving a business a competitive edge.
In this brief guide, we’ll cover what capital expenditure is, as well as why understanding it is critical, regardless of the industry your business is in.
What is a capital expenditure (CapEx)?
Capital expenditure (CapEx) is money that is spent to acquire, repair, update, or improve a fixed company asset, such as a building, business, or equipment. A CapEx is different from an everyday business, which falls under the operating expense category.
While often used interchangeably, operating expenses (OpEx) and capital expenditures (CapEx) are not exactly the same.
The major differences between CapEx and OpEx are that a capital expenditure is a one-time cash outlay, not recurring, and it impacts a long-term asset, or something that can’t be deducted in full in the year in which it was bought.
A new personal printer can be fully written off as an expense when you buy it, but a new roof for your offices cannot be—that’s a major expenditure, or CapEx.
OpEx are generally deducted from revenue as an expense and the profits that are left over are invested in CapEx, to create future growth and opportunity.
What is useful life?
When calculating capital expenditures, it’s critical to understand the concept of “useful life.” Useful life refers to the estimated and generally agreed upon shelf life of a specific business asset. Because capital expenditures are long-term investments, for assets to fall under the CapEx destination, the investments must have a useful life of one year or more.
A CapEx is amortized, or its value is deducted a little each year based on the total cost and its expected useful life. A car’s useful life is now considered to be five years, according to the IRS, while a new building’s is 39. So the cost of those assets is divided by their useful life to determine how much your business can deduct each year as depreciation.
That doesn’t mean a car is expected to stop working in year six or that a building will crumble in year 40, only that, for the IRS’ purposes, the value can be depreciated in that time span.
Useful life guidelines are established by the IRS and are incredibly important to understand when considering capital expenditures. Without a full picture of the useful life of assets being invested in, you could lose out on some fairly significant tax advantages.
Capital expenditure examples
Capital expenditure is one of many types of expenditures businesses need to understand at a high level. CapEx investments need to fall into one of these categories to qualify as such:
- Acquiring, or buying, a fixed tangible asset, such as a building, or intangible asset, such as a patent or license.
- Upgrading an existing asset to expand its capacity or capability, such as a computer network or major equipment.
- Renovating an obsolete or non-functioning asset to make it usable.
- Repairing an asset to make it usable once again.
- Adapting an asset for a new use, different from what it had been previously used for.
- Starting or acquiring a new business.
Again, capital expenditures refer to long-term investments related to your business over a multi-year timeline. Any investment with a useful life expectancy of under a year would not qualify.
How to calculate capital expenditures
Referencing your businesses income statement and balance sheet, you can calculate capital expenditures using the following formula:
CapEx = PPE (current period) – PPE (prior period) + Depreciation (current period)
PPE refers to “property, plant, and equipment.”
While the formula is relatively straightforward, it's highly recommended to seek the guidance of both a tax and financial professional to ensure you are calculating your capital expenditures properly.
CapEx and financial statements
While OpEx are line items in the expense category on a cash flow statement, CapEx are typically found under the heading “Investment in property, plant, or equipment.”
CapEx usually requires a sizable financial investment and, for that reason, often needs the approval of the company’s board of directors or shareholders.
Understanding capital expenditures
If you’re just starting your ecommerce business, you may not be in the position to invest millions of dollars in upgrading your business. And yet, understanding the role capital expenditures plays in the competitive business landscape today is more important than ever before.
Even if you’re not there yet, having a high level understanding of how CapEx could help you grow your business down the line can give you a massive leg up on your competition.
Capital expenditure FAQ
How do you calculate capital expenditures (CapEx)?
Calculating capital expenditures is relatively straightforward. Here’s the four-step process.
- Retrieve your company's financial statements, including cash flow statements, income statements etc.
- Subtract the value of your current fixed assets from the value of the fixed assets from last year.
- Subtract the accumulated depreciation.
- Add the total depreciation value to the difference between fixed assets the current year and previous year.
What is the capital expenditure formula?
Capital expenditures = PPE (current period) - PPE (prior period) + depreciation (current period)
What is the difference between OpEx and CapEx?
CapEx (Capital expenditure) refers to investments to a business long term. OpEx (operating expenses) refer to the everyday expenses a business incurs throughout standard operation.