Capital expenditures (CapEx) are crucial investments that a company makes to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. Often, companies undertake new projects or investments using CapEx to increase their scope of operations or add future economic benefits.
Key Takeaways
- Capital expenditures are payments made for goods or services that are recorded on a company’s balance sheet rather than being expensed on the income statement immediately.
- These expenditures are essential for companies to maintain existing property and equipment and to invest in new technology and assets for growth.
- Items with a useful life of less than one year must be expensed immediately, and thus typically are not considered CapEx.
- Unlike CapEx, operating expenses (OpEx) are short-term expenses used for day-to-day business operations.
- Examples of CapEx include purchasing land, vehicles, buildings, or heavy machinery.
Understanding Capital Expenditures (CapEx)
CapEx represents an investment that can help gauge how much a company is putting into maintaining or expanding business operations. Capitalizing an asset implies spreading the cost over its useful life, which is shown on the balance sheet.
The level of CapEx can vary significantly depending on the industry. For example, industries like oil exploration, telecommunications, manufacturing, and utilities are particularly capital-intensive.
CapEx details can be found in the cash flow from investing activities section of a company’s cash flow statement. It may be listed as capital spending, the purchase of property, plant, and equipment (PP&E), or acquisition expenses.
One technique for calculating CapEx involves using data from a company’s income statement and balance sheet as follows:
- Find the current depreciation expense on the income statement.
- Identify the property’s prior and current balance values for PP&E on the balance sheet.
- Use the change in PP&E along with the current period’s depreciation expense to determine CapEx spending.
Types of CapEx
In each of these categories assets drive long-term value for the company:
- Buildings: for office space, manufacturing, storage, etc.
- Land: for future development or investment.
- Equipment and machinery: used in manufacturing.
- Computers or servers: supporting company operations and logistics.
- Furniture: to equip office spaces.
- Vehicles: for transportation and business activities.
- Patents: intellectual property adding long-term value.
Formula and Calculation of CapEx
definion and formula for determining CapEx from company financial statements:
CapEx = Δ PP&E + Current Depreciation
where:
- CapEx = Capital expenditures
- Δ PP&E = Change in property, plant, and equipment
It also helps measure Free Cash Flow to Equity (FCFE), indicating cash availability to equity shareholders:
FCFE = EP − (CE − D) × (1 − DR) − ΔC × (1 − DR)
where:
- FCFE = Free cash flow to equity
- EP = Earnings per share
- CE = CapEx
- D = Depreciation
- DR = Debt ratio
- ΔC = Change in net working capital
Alternatively,
FCFE = NI − NCE − ΔC + ND − DR
where:
- NI = Net income
- NCE = Net CapEx
- ND = New debt
- DR = Debt repayment
The greater the CapEx for a firm, the lower the FCFE.
Special Considerations
The CapEx metric can also be used in various ratios like the Cash Flow-to-Capital Expenditures (CF-to-CapEx) ratio, which indicates a company’s ability to comfortably acquire long-term assets with free cash flow. Generally,
- A ratio greater than 1 means sufficient free cash flow for asset acquisition.
- A ratio under 1 may indicate cash inflow challenges requiring alternative funding for asset purchases.
CapEx vs. Operating Expenses (OpEx)
Capital expenditure should be differentiated from operating expenses (OpEx). Operating expenses cover regular short-term operational costs and are fully deductible from taxable income in the same year they occur. CapEx results from acquiring or significantly improving long-term assets, capitalized, and depreciated over their useful lives.
Examples of OpEx include rent, wages, and utilities costs. Contrarily, buying new equipment qualifies as a CapEx as the investment departs from regular business operations cycles.
Examples of CapEx
For instance, Apple, Inc. had comprehensive CapEx reflections in its 2023 fiscal financial statements, portraying:
Highlights:
- Property, Plant, and Equipment (PP&E): $43.7 billion, net of accumulated depreciation.
- Actual gross PP&E: $114.6 billion, primarily in machinery, equipment, and software ($78.3 billion).
- Accumulated depreciation: $70.9 billion.
Apple’s data presents a clear picture of CapEx components and long-term asset management.
Real-World CapEx Application
Consider ABC Company and XYZ Corporation with annual CapEx of $7.46 billion and $1.25 billion, respectively. Their cash flow from operations stood at $14.51 billion and $6.88 billion correspondingly.
CF-to-CapEx Formula:
CF/CapEx = Cash Flow from Operations / CapEx
Calculations revealed:
- ABC Company:
CF/CapEx = $14.51 billion / $7.46 billion
CF/CapEx = 1.94
- XYZ Corporation:
CF/CapEx = $6.88 billion / $1.25 billion
CF/CapEx = 5.49
Industry expertise should be noted for fair CapEx requirement comparisons.
Key Insights on CapEx Investments
CapEx represents investments vital for developing or maintaining business operations—unlike the recurring nature of OpEx. Expensive equipment purchases or infrastructure investments qualify as CapEx, depreciating over years.
CapEx Tax Considerations
CapEx isn’t directly tax-deductible but contributes to tax reduction through depreciation. For instance, a $1 million equipment purchase depreciated over 10 years deducts $100,000 annually from a company’s pre-tax income.
Charting the Divergence Between CapEx and OpEx
While CapEx supports significant asset purchases or improvements beyond a year, OpEx covers routine, consistent expenditures like rent or salaries. CapEx affects taxes indirectly through depreciation, while OpEx impacts taxes directly.
Illustration of CapEx
A company purchasing a vehicle records and depreciates it over its useful life under CapEx. Conversely, fueling the vehicle reflects OpEx due to the expense’s short-term nature.
The Bottom Line
Capital expenditures shape financial strategies, be it acquiring new assets or upgrading existing ones, showing up on the balance sheet, and depreciated over the asset’s useful life.
Related Terms: Operating Expenses (OpEx), Property, Plant, and Equipment (PP&E), Cash Flow to Capital Expenditures Ratio, Free Cash Flow to Equity (FCFE), Depreciation.
References
- Internal Revenue Service. “Publication 535, Business Expenses”.
- Apple. “Form 10-K for the Year Ending Sept. 30, 2023”, Page 30.
- Apple. “Form 10-K for the Year Ending Sept. 30, 2023”, Page 39.
- Internal Revenue Service. “Topic No. 704 Depreciation”.
