How capital expenditure management can drive performance

One of the quickest and most effective ways for organizations to preserve cash is to reexamine their capital investments. The past two years have offered a fascinating look into how different sectors have weathered the COVID-19 storm: from the necessarily capital expenditure–starved airport industry to the cresting wave of public-sector investments in renewable infrastructure and anticipation of the next mining supercycle. Indeed, companies that reduce spending on capital projects can both quickly release significant cash and increase ROIC, the most important metric of financial value creation (Exhibit 1).

This strategy is even more vital in competitive markets, where ROIC is perilously close to cost of capital. In our experience, organizations that focus on actions across the whole project life cycle, the capital project portfolio, and the necessary foundational enablers can reduce project costs and timelines by up to 30 percent to increase ROIC by 2 to 4 percent. Yet managing capital projects is complex, and many organizations struggle to extract cost savings. In addition, ill-considered cuts to key projects in a portfolio may actually jeopardize future operating performance and outcomes. This dynamic reinforces the age-old challenge for executives as they carefully allocate marginal dollars toward value creation.

Companies can improve their odds of success by focusing on areas of the project life cycle— capital strategy and portfolio optimization , project development and value improvement, and project delivery and construction—while investing in foundational enablers.

Cracking the code on capital expenditure management

Despite the importance of capital expenditure management in executing business strategy, preserving cash, and maximizing ROIC, most companies struggle in this area for two primary reasons. First, capital expenditure is often not a core business; instead, organizations focus on operating performance, where they have extensive institutional knowledge. When it comes to capital projects, executives rely on a select few people with experience in capital delivery. Second, capital performance is typically a black box. Executives find it difficult to understand and predict the performance of individual projects and the capital project portfolio as a whole.

Across industries, we see companies struggle to deliver projects on time and on schedule (Exhibit 2). In fact, cost and schedule overruns compared with original estimates frequently exceed 50 percent. Notably, these occur in both the public and private sectors.

The COVID-19 pandemic has accelerated and magnified these challenges. Governments are increasingly viewing infrastructure spending as a tool for economic stimulus, which amplifies the cyclical nature of capital expenditure deployments. At the same time, some organizations have had to make drastic cutbacks in capital projects because of difficult economic conditions. The reliance on just a few experienced people when travel restrictions necessitated a remote-operating model further increased the complexity. As a result, only a few organizations have been able to maintain a through-cycle perspective.

In addition, current inflation could put an end to the historically low interest rates that companies are enjoying for financing their projects. As the cost of capital goes up, discipline in managing large projects will become increasingly important.

Improving capital expenditure management

In our experience, the organizational drivers that impede capital expenditure management affect all stages of a project life cycle, from portfolio management to project execution and commissioning. Best-in-class capital development and delivery require companies to outperform in three main areas, supported by several foundational enablers (Exhibit 3).

Recipes for capturing value

Companies can transform the life cycle of a capital expenditure project by focusing on three areas: capital strategy and portfolio optimization, project development and value improvement, and project delivery and construction. While the savings potential applies to each area on a stand-alone basis, their impact has some overlap. In our experience, companies that deploy these best practices are able to save 15 to 30 percent of a project’s cost.

Capital strategy and portfolio optimization

The greatest opportunity to influence a project’s outcome comes at its start. Too often, organizations commit to projects without a proper understanding of business needs, incurring significant expense to deliver an outcome misaligned with the overall strategy. Indeed, a failure to adequately recognize, price, and manage the inherent risks of project delivery is a recurring issue in the industry. Organizations can address this challenge by following a systematic three-step approach:

Assess the current state of capital projects and portfolio. It’s essential to identify strengths, areas of improvement, and the value at stake. To do so, organizations must build a transparent and rigorously tested baseline and capital budget, which should provide a clear understanding of the overall capital expenditure budget for the coming years as well as accurate cost and time forecasts for an organization’s portfolio of capital projects.

Ensure capital allocation is linked to overall company strategy. This step involves reviewing sources and uses of cash and ensuring allocated capital is linked to strategy. Companies must set an enterprise-wide strategy , assess the current portfolio against the relevant market with forward-looking assessments and cash flow simulation, and review sources and uses of cash to determine the amount of capital available. Particular focus should be given to environmental, social, and governance (ESG) considerations—by both proactively managing risks and capturing the full upside opportunity of new projects—because sustainability is becoming a real source of shareholder value (Exhibit 4). With this knowledge, organizations can identify internal and external opportunities to strengthen their portfolio based on affordability and strategic objectives.

Optimize the capital portfolio to increase company-wide ROIC. Executives should distinguish between projects that are existing or committed, planned and necessary (for legal, regulatory, or strategic requirements), and discretionary. They can do so by challenging a project’s justification, classifications, benefit estimates, and assumptions to ensure they are realistic. This analysis helps companies to define and calibrate their portfolios by prioritizing projects based on KPIs and discussing critical projects not in the portfolio. Executives can then verify that the portfolio is aligned with the business strategy, risk profile, and funding constraints.

For example, a commercial vehicle manufacturer recently undertook a rigorous review of its project portfolio. After establishing a detailed baseline covering several hundred planned projects in one data set, the manufacturer classified the projects into two categories: must-have and discretionary. It also considered strategic realignment in light of a shift to e-mobility and the implications on investments in internal-combustion-engine vehicles. Last, it scrutinized individual maintenance projects to reduce their scope. Overall, the manufacturer uncovered opportunities to decrease its capital expenditure budget by as much as 20 percent. This strict review process became part of its annual routine.

Project development and value improvement

While value-engineering exercises are common, we find that 5 to 15 percent of additional value is typically left on the table. Too often, organizations focus on technical systems and incremental improvements. Instead, executives should consider the full life cycle cost across several areas:

Sourcing the right projects with the right partners. Companies must ensure they are sourcing the right projects by aligning on prioritization criteria and identifying the sectors to play in based on their strategy. Once these selections are made, organizations can use benchmarking and advanced-analytics tools to accelerate project timelines and improve planning. Building the right consortium of contractors and partners at the outset and establishing governance and reporting can have a huge impact. Best-in-class teams secure the optimal financing, which can include public and private sources, by assessing the economic, legal, and operational implications for each option.

A critical success factor is a strong tendering office, which focuses on choosing better projects. It can increase the likelihood of winning through better partnerships and customer insights and enhance the profitability of bids with creative solutions for reducing cost and risk. Best-in-class tendering offices identify projects aligned with the company’s strategy, have a clear understanding of success factors, develop effective partnerships across the value chain, and implement a risk-adjusted approach to pricing.

Achieve the full potential of the preconstruction project value. Companies can take a range of actions to strengthen capital effectiveness. For example, they should consider the project holistically, including technical systems, management systems, and mindsets and behaviors. To ensure they create value across all stages of the project life cycle, organizations should design contract and procurement interventions early in the project. An emphasis on existing ideas and proven solutions can help companies avoid getting bogged down in developing new solutions. For instance, a minimum-technical-solution approach can be used to identify the highest-value projects by challenging technical requirements once macro-elements are confirmed.

Companies should also seek to formalize dedicated systems and processes to support decision making and combat bias. We have identified five types of biases to which organizations should pay close attention (Exhibit 5). For instance, interest biases should be addressed by increasing transparency in decision making and aligning on explicit decision criteria before assessing the project. Stability biases can also be harmful. We have seen it too many times: companies have a number of underperforming projects that just won’t die and that take up valuable and already limited available resources. Organizations should invest in quickly determining when to halt projects—and actually stop them.

Setting up a system to take action in a nonbiased way is a crucial element of best-in-class portfolio optimization. Changing the burden of proof can also help. One energy company counterbalanced the natural desire of executives to hang on to underperforming assets with a systematic process for continually upgrading the company’s portfolio. Every year, the CEO asked the corporate-planning team to identify 3 to 5 percent of the company’s assets that could be divested. The divisions could retain any assets placed in this group but only if they could demonstrate a compelling turnaround program for them. The burden of proof was on the business units to prove that an asset should be retained, rather than just assuming it should.

An effective governance system ensures that all ideas generated from project value improvements are subject to robust tracking and follow-up. Further, the adoption of innovative digital and technological solutions can enhance standardization, modularization, transparency, and efficiency. A power company recently explored options to phase out coal-powered energy using a project value improvement methodology and a minimum technical solution. The process helped to articulate options to maximize ROI and minimize greenhouse-gas emissions. An analysis of each option, using an idea bank of more than 2,000 detailed ideas, let the company find solutions to reduce investment on features with little value added, reallocate spending to more efficient technologies, and better adjust capacity configurations with business needs. Ultimately, the company reduced capital costs by 30 percent while increasing CO 2 abatement by the same amount.

Designing the right project organization. An open, collaborative, and result-focused environment enabled by stringent performance management processes is critical for success, regardless of the contractual arrangement between owners and contractors. Improving capital project practices is possible only if companies measure those practices and understand where they stand compared with their peers. The organization should be designed with a five-year capital portfolio in mind and built by developing structures for project archetypes and modeling the resources required to deliver the capital plan. A rigorous stage-gate process of formal reviews should also be implemented to verify the quality of projects moving forward. Too many projects are rushed through phases with no formal review of their deliverables, leading to a highly risky execution phase, which usually results in delays and cost overruns.

As successful organizations demonstrate, addressing organizational health in project teams is as important as performance initiatives. McKinsey research has found that the healthiest organizations generate three times higher returns than companies in the bottom quartile and more than 60 percent higher returns compared with companies in the middle two quartiles. 1 Scott Keller and Bill Schaninger, Beyond Performance 2.0: A Proven Approach to Leading Large-Scale Change , second edition, Hoboken, NJ: Wiley, 2019.

Project delivery and construction

Since the root causes of poor performance—project complexity, data quality, execution capabilities, and incentives and mindsets—can be difficult to identify and act on, organizations can benefit from taking the following actions across project delivery and construction dimensions.

Optimize the project execution plan. Organizations should embrace principles of operations science to develop an optimized configuration for the production system, as well as set a competitive and realistic baseline for the project. This execution plan identifies the execution options that could be deployed on the project and key decisions that need to be made. Companies should also break the execution plan into its microproduction systems and visualize the complicated schedule. Approaching capital projects as systems allows companies to apply operations science across process design, capacity, inventory, and variability.

Contract, claims, and change orders management. While claims are quite common on capital projects, proactive management can keep them under control and allow owners to retain significant value. Focusing on claims avoidance when drafting terms and conditions can head off many claims before they arise. In addition, partnering with contractors creates a more collaborative environment, making them less inclined to pursue an aggressive claims strategy. To manage change orders on a project, companies should address their contract management capability, project execution change management, and project closeout negotiation support. A European chemical company planning to build greenfield infrastructure in a new Asian geography recently employed this approach. It reduced risk on the project by bringing together bottom-up, integrated planning and performance management with targeted lean-construction interventions. By doing so, the company reduced the project’s duration by a year, achieved on-time delivery, and stayed within its €1 billion budget.

Enablers of the capital transformation

These three value capture areas must be supported by a capable organization with the right tools and processes—what we call the “transformational chassis.” To establish this infrastructure, organizations should focus on several activities.

Performance management

The best organizations institute a performance management system to implement a cascading set of project review meetings focused on assessing the progress of value-creation initiatives. Building on a foundation of quality data, the right performance conversations must take place at all levels of the organization.

Companies should also be prepared to reexamine their stage-gate governance system to shift from an assurance mindset (often drowning in bureaucracy and needless reporting) to an investor mindset. Critical value-enabling activities should be defined at each stage of the project life cycle, supported by a playbook of best practices for execution and implemented by a project review board. While governance processes exist, they often involve reporting without decision making or are not focused on the right outcomes—for example, ensuring that the investment decision and thesis remain valid through a project’s life. Quite often, companies provide incentives for project managers to execute an outdated project plan rather than deliver against the organization’s needs and goals.

Creating project transparency is also critical. Companies should establish a digital nerve center—or control tower—that collects field-level data to establish a single source of truth and implement predictive analytics. Equally important, companies must address capability building to ensure that the team has a solid understanding of the baseline and embraces data-based decision making.

Companies should stand up delivery teams that integrate owner and contractor groups across disciplines and institute a consistent and effective project management rhythm that can identify risks and opportunities over a project’s duration. Once delivery teams prioritize the biggest opportunities, dedicated capacity should be allocated to solve a project’s most challenging problems. Finally, companies should build and deploy comprehensive programs that improve culture and workforce capabilities throughout the organization, including the front line.

Capital analytics

Many organizations struggle to get a clear view of how projects are performing, which limits the possibility for timely interventions, decision making, and resource planning. By digitalizing the performance management of construction projects using timely and transparent project data, companies can track value capture and leading indicators while making data available across the enterprise. Using a single source of truth can reduce delivery risk, increase responsiveness, and enable a more proactive approach to the identification of issues and the capture of opportunities. The most advanced projects build automated, real-time control towers that consolidate information across systems, engineering disciplines, project sites, contractors, and broader stakeholders. The ability to integrate data sets speeds decision making, unlocks further insights, and promotes collaborative problem solving between the company that owns the capital project and the engineering, procurement, and construction company.

Ways of working

In many cases, executives are unwilling to engage in comprehensive capital reviews because they lack a sufficient understanding of capital management processes, and project managers can be afraid to expose this lack of proficiency. Agile practices can facilitate rapid and effective decision making by bringing together cross-functional project teams. Under this approach, organizations establish daily stand-ups, weekly showcases, and fortnightly sprints to help eliminate silos and maintain a focus on top priorities. Agility must be supported by an organizational structure, well-developed team capabilities, and an investment mindset. Organizations should also build skills and establish a culture of cooperation to optimize their capital investments.

We do recognize that getting capital expenditure management right feels like a lot to do well. And although many of these tasks are somehow done by a slew of companies, pockets of organizational excellence can be undermined instantly (and sometimes existentially) by one big project that goes wrong or a strategic misfire that pushes an organization from being a leader to a laggard in the investment cycle. In some ways, capital expenditure management leaders face similar challenges to those in other functions that have already undergone major productivity improvements: often these challenges are not technical problems but instead relate to how people work together toward a common goal.

Yet we believe organizations have a significant opportunity to fundamentally improve project outcomes by rethinking traditional approaches to project delivery. Sustainable improvements can be achieved by resizing the project portfolio, optimizing the cash flows for individual projects, and improving and reducing individual project delivery risk.

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What Is Capital Expenditure (CapEx)?

Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest.

capital expenditure in business plan

  • Definition/Examples of Capital Expenditure

How Capital Expenditures Work

Types of capital expenditure.

  • Capital vs. Operational Expenditure

What It Means for Individual Investors

Hill Street Studios / Getty Images

Capital expenditure is money a company uses to acquire new assets, add to current assets, or improve assets for the benefit of improving a business, such as buying new equipment.

Key Takeaways

  • Capital expenditures are money a company uses to improve or acquire new assets with the objective of growing and improving the business as a whole.
  • Capital expenditures are often referred to as CapEx or capital expenses.
  • Examples of capital expenditures include improving or purchasing assets such as property and equipment.
  • Operational expenditures are short-term, day-to-day expenses, whereas capital expenditures are long-term investments in acquiring and improving assets.
  • A business with a proven track record of a sound capital expenditure strategy may be a potential investment opportunity, with other financial factors considered.

Definition and Example of Capital Expenditure

Capital expenditure, also known as CapEx, is money a business spends to acquire, improve, or maintain physical long-term assets . Capital expenditures are used to develop a new business or as a long-term investment of an existing business.

Capital expenditures are necessary for a company to grow its current business operations. They are the part of the budget allocated to maintaining and improving the equipment and assets to keep the business running. They can also be expenses related to the expansion of the company by acquiring new assets.

  • Alternative name: Capital expenses, CapEx

For example, a plastic manufacturing plant may purchase property and infrastructure to expand its business capacity. All the expenses related to buying the property, buildings, equipment, and machinery would be capital expenditures.

Costs associated with improving a machinery’s useful life would also be considered a capital expenditure because they help extend the useful life of the equipment.

Rather than being shown as an expense, capital expenditure is recorded or capitalized as a long-term asset. It is considered an investment because the company is expanding or maintaining its business and assets.

Examples of common capital expenditures are purchasing long-term assets such as equipment, property, tools, infrastructure, machinery, warehouses, furniture, and vehicles; or intangible assets like patents and licenses.

However, expenses related to the repair and general maintenance of an asset are not considered a capital expenditure. Instead, they’re classified as “repairs.”

The IRS categorizes types of capital expenses that businesses can capitalize: business startup costs, business assets, and improvements. These specific expenses may include:

  • Intangible assets (patents, licenses, trademarks, etc.)

In short, any expenditures related to acquiring new assets such as those listed above or upgrading these assets is a type of capital expenditure.

Capital Expenditure vs. Operational Expenditure

Capital expenditures are related to growing and improving the assets of a business. They are considered long-term investments. Operational expenditures (OpEx), on the other hand, are expenditures related to the day-to-day operation of a business.

Here’s how they compare:

For investors to better understand the financial health and prospects of a business, they should thoroughly understand the capital expenditures.

A company that has a sound strategy for how they manage its capital expenditures can provide a potential investment opportunity . Of course, investors should consider many other aspects of a company before investing.

After all, a company that takes its profits and reinvests them into promising, long-term assets may have a well-developed plan for long-term growth. Conversely, a company that does not focus well on investing in its growth may be headed for challenges.

IRS. " Business Expenses ." Page 3. Accessed Aug. 30, 2021.

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Understanding Capital Expenditure: A Comprehensive Guide

Understanding Capital Expenditure: A Comprehensive Guide

What is Capital Expenditure (Capex)?

Capital expenditure examples.

  • Purchasing new equipment
  • Building a new factory
  • Renovating an office building
  • Acquiring a new business
  • A company builds a new research and development facility.
  • A company acquires a competitor.

Types of Capital Expenditures

  • maintenance CapEx (for upkeeping current assets),
  • growth CapEx (for buying new assets to expand business),
  • and regulatory CapEx (for meeting statutory requirements).

Maintenance Capex

  • maintenance

Growth Capex

Regulatory capex, how to use capex in business planning and management.

  • A company is struggling to meet customer demand.
  • The company has decided to buy a new production line.
  • The new production line increases the company's output by 20%.
  • The company is now able to meet customer demand and increase its sales.
#CaminoTip By planning for capital expenditures in your operating budget, you can ensure that you have the money available to make these investments when needed.

The Role of Capital Expenditure in Corporate Financial Management

  • Investing in growth. You can use CapEx to invest in new products, services, or markets. This can help companies to grow and expand their business.
  • Improving efficiency. Companies can use CapEx to improve the efficiency of existing operations. This can lead to lower costs and increased profits.
  • Maintaining assets. You can use CapEx to keep existing assets in good working order. This can help extend the assets' life and prevent costly repairs or replacements.
  • Managing risk. Companies can use CapEx to manage risk. For example, a company might invest in new technology to reduce its reliance on a particular supplier.
#DidYouKnow When planning a capital project, make sure to consider the total cost of ownership (TCO). The TCO includes the initial purchase price of the asset, as well as the costs of maintenance, repairs, and disposal. By considering the TCO, you can ensure that you are making a wise investment.

Capital Expenditures and Its Impact on a Company's Financial Health

Reasons why capex is important in strategic financial planning, improve a company's efficiency and productivity, grow and expand its business, improve its competitive position, manage risk, capital expenditure formula.

CapEx = PP&E (Current Year) + Depreciation (Current Year) - PP&E (Last Year)
  • capital budgeting
  • financial modeling

Step-by-Step Guide: How to Calculate Capital Expenditures

Identify property, plant, and equipment costs for the current and previous year, identify the current year's depreciation costs, use the capital expenditure formula.

  • investment trends
  • overall financial health
  • PP&E for the current year: $600,000
  • PP&E for the previous year: $500,000
  • Depreciation for the current year: $50,000
CapEx = $600,000 (Current Year PP&E) + $50,000 (Current Year Depreciation) - $500,000 (Previous Year PP&E) = $150,000
#CaminoTip Carefully plan your capital expenses to ensure they align with your business goals and will provide a return on investment.

Challenges with Capital Expenditures and How to Overcome Them

  • sound financial planning
  • thorough market research
  • regular monitoring of capital projects
#CaminoTip This number can significantly impact your financial statements . 

Overestimation of Returns

Underestimation of costs.

  • installation
  • potential downtime during setup

Misalignment with Business Strategy

Liquidity issues, regulatory challenges, technological obsolescence, how to manage and optimize capital expenditure in your organization.

  • taking calculated risks
  • adapting to changing market dynamics
  • regular audits
  • effective collaboration across departments
  • leveraging technology

Align CapEx With Business Strategy

  • growth-oriented, like entering a new market
  • operational, like improving efficiency

Implement a Rigorous Approval Process

Regularly review capex projects, leverage technology.

  • streamline the process
  • provide valuable data for decision-making
  • improve visibility and control over your capital spending

Maintain a Balanced Portfolio

Involve cross-functional teams, optimize asset utilization, provide training, capital expenditure vs. revenue expenditure.

  • Capital expenditure is a long-term investment, while revenue expenditure is a short-term expense.
  • Companies capitalize capital expenditures on the balance sheet and expense revenue expenditures on the income statement.
  • Capitalized expenditure is tax-deductible, while revenue expenditure is not.

Capital Expenditure Vs. Operating Expense

  • Timing. CapEx is a one-time expense, while OpEx is an ongoing expense.
  • Impact. CapEx can significantly impact a company's financial performance, while OpEx typically has a smaller impact.
  • Accounting treatment. Companies treat capital spending as an asset on the balance sheet and expense operational expenses on the income statement.

Improving Business Health

  • strategic business planning
  • financial management

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Capital Expenditure (Capex)

Step-by-Step Guide to Understanding Capital Expenditures (Capex)

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What is Capital Expenditure?

Capital Expenditure (Capex) refers to a company’s long-term investments in fixed assets (PP&E) to facilitate growth in the foreseeable future.

For the vast majority of companies, Capex is one of the most significant outflows of cash that can have a major impact on their free cash flows.

Capital Expenditure (Capex)

How Does a Capital Expenditure Work?

Capital expenditure, often abbreviated as “Capex,” describes the funds spent by a company to acquire, upgrade, and maintain physical fixed assets , such as property, buildings, and equipment.

For example, the act of repairing a roof, building a new factory, or purchasing a piece of equipment would each be categorized as a capital expenditure.

  • Capital Expenditure (Capex) → Capex is distinct from an operating expense (Opex) because the underlying asset – i.e. the fixed asset associated with the capital spending – is expected to generate long-term benefits in excess of 12 months.
  • Operating Expenses (Opex) → In contrast, operating expenses refer to the day-to-day costs incurred in the ordinary course of business, such as selling, general, and administrative (SG&A) expenses.

With regard to the proper accounting methodology, capital expenditures (Capex) must be depreciated – i.e. “spread out” – across the useful life of the fixed asset (PP&E) rather than being recognized in the year of actual incurrence.

The rationale for gradually reducing the fixed asset (PP&E) balance via depreciation – a non-cash expense recognized on the income statement – is intended to align the cost with the revenue generated, i.e. the “matching principle.”

What are Examples of Capital Expenditure?

Capital expenditures (Capex) include the purchase of new fixed assets and repairing, or upgrading existing long-term assets, such as the following examples:

  • Property → Buildings, Land, Offices
  • Equipment → Transportation Vehicles, Machinery, Office Desks, Chairs
  • Hardware → Computers, Laptops, Phones
  • Software → CRM, ERP, Cybersecurity, Infrastructure

How to Calculate Capex?

The capital expenditure (Capex) of a company in a given period can be determined by tracking the changes in the company’s fixed assets (or PP&E) balances recorded on the balance sheet , along with the current period’s depreciation expense from the income statement.

However, a separate line item for the depreciation expense is seldom found on the income statement .

Therefore, the depreciation expense should be obtained from the cash flow statement (CFS) , where it is treated as a non-cash add-back.

If deprecation is consolidated with amortization , simply copy the D&A amount in the filing and use the search function to find the footnotes that break out the precise depreciation expense amounts.

To calculate capital expenditure (Capex), subtract the current period PP&E from the prior period PP&E and then add depreciation.

The reason that depreciation is added back is attributable to the fact that depreciation is a non-cash item.

Because of the guidelines set by accrual accounting reporting standards, depreciation expense must be recognized on the income statement (and usually embedded within COGS and Opex).

While depreciation expense reduces the carrying value of fixed assets (PP&E) on the balance sheet, there is no actual cash outlay.

Hence, the depreciation expense is treated as an add-back in the cash from operations (CFO) section of the cash flow statement (CFS) to reflect that no real cash outlay occurred.

Capex Formula

The current period PP&E can be calculated by taking the prior period PP&E, adding capital expenditure (Capex), and subtracting depreciation.

If the formula is rearranged to solve for capital expenditure (Capex), the value of a company’s capex for a given period can be determined.

The capex formula subtracts the ending PP&E by the beginning PP&E balance, and then adds depreciation.

  • Ending PP&E → Current Period PP&E Balance, i.e. End of Period (EoP)
  • Beginning PP&E → Prior Period PP&E Balance, i.e. Beginning of Period (BoP)
  • Depreciation → (Total PP&E Cost – Salvage Value) ÷ Useful Life Assumption

Therefore, the prior year’s PP&E balance is deducted from the current year’s PP&E balance.

Why? The difference between the prior and current period PP&E represents the change in PP&E.

Since the increase or decrease in PP&E reflects the Capex spend, the annual depreciation recognized in the same period is added back because the expense is a non-cash item.

Maintenance Capex vs. Growth Capex: What is the Difference?

There are two different types of classifications that capital expenditure (Capex) is categorized into:

  • Maintenance Capital Expenditure (Capex)  → The required ongoing expenditures of a company to continue operating in its current state (e.g., repair of broken equipment, periodic system updates). Maintenance Capex involves mandatory spending to continue operations and is considered to be the spending associated with sustaining the current level of revenue and profit levels. If not replenished, ongoing operations wouldn’t be able to continue, which would negatively impact its performance.
  • Growth Capital Expenditure (Capex) → On the other hand, growth Capex is the discretionary spending of a company related to new growth strategic plans to acquire more customers and increase geographic reach. Growth Capex is when a company undertakes discretionary investments to increase its revenue and profits beyond historical levels, which usually entails grabbing more market share, geographic expansion, introducing new product lines, etc.

Capex Calculator

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

Get the Excel Template!

1. revenue growth assumptions.

Suppose a company has revenue of $60.0m at the end of the current period, Year 0.

The growth rate of revenue is going to be 10.0% in the first year and ramp down by 2.0% each year until it reaches 2.0% in Year 5.

  • Revenue, Year 0 = $60 million
  • Revenue Growth %, Step Function = -2% per Year

2. Maintenance vs. Growth Capex Forecast

In terms of historical values for Year 0, the maintenance capital expenditure was $1.2m, while the growth capex was $1.8m. We can see that the total capex comes out to $3.0m in Year 0.

Moving onto the assumptions, maintenance capex as a percentage of revenue was 2.0% in Year 0 – and this % of revenue assumption is going to be straight-lined across the projection period.

  • Maintenance Capex % Revenue = 2.0% (“Straight-Lined”)

For example, the maintenance capex in Year 2 is equal to $71.3m in revenue multiplied by 2.0%, which comes out to $1.6m.

In contrast, growth capex as a percentage of revenue is assumed to have fallen by 0.5% each year. Since the growth rate was 3.0% in Year 0, the percent assumption in Year 5 will have dropped to 0.5%.

  • Growth Capex % Revenue, Year 0 = 3.0%
  • Growth Capex % Revenue, Step Function = (0.5%) per Year

The reasoning behind this assumption is the need to align the slow-down in revenue with a lower amount of growth capex.

3.  Capital Expenditure Calculation Example

Once those two metrics are filled out for the entire forecast, they can be added together for the total capital expenditures for each year.

The total capex decreases as a percentage of revenue from 5.0% to 2.0% by the final year.

There are two additional assumptions listed below the maintenance vs. growth calculation area:

  • Year 0 Depreciation = $2 million
  • Year 0 PP&E, net = $25 million

If we have the total capital expenditures and depreciation amounts, net PP&E can be computed, which is what we’re working towards.

4. Depreciation to Capex Ratio Analysis

In the historical period (Year 0), the ratio between depreciation and capex, expressed as a percentage, came in at 66.7%.

  • Depreciation to Capex Ratio (%) = 66.7%

Since we’re aware that the depreciation to capex ratio should gradually shift towards 100% (or 1.0x), we’ll smooth out the assumption to reach 100% by the end of the forecast.

For each year, the formula for the assumption will be equal to the prior % capex value plus the difference between 66.7% and 100.0% divided by the number of years projected (5 years).

After doing so, we can calculate 6.7% as the amount added each year. To confirm, we can see that depreciation and total capex were both $2.0m in Year 5.

5. Capex Calculation Example

In the final two steps, we’ll project PP&E and then back out the implied capital expenditure amount using the formula mentioned earlier.

For example, in Year 1, the prior PP&E was $25.0m while capex was $3.0m and depreciation is $2.2m. Upon entering them into the formula, we get $25.8m as the current period PP&E balance.

  • Ending PP&E, Year 1 = $25.0 million + $3.0 million – $2.2 million = $25.8 million

Once repeated for each forecasted year, the implied capex (as a check) can be calculated by the change in PP&E (i.e., the difference between the current and prior period PP&E) and adding back the depreciation.

So in Year 5, the ending PP&E balance remains at $26.9m (i.e. net change of zero), while the depreciation expense is $2.0m, meaning the implied capital expenditure (capex) is $2.0m.

Capex Calculator

What is a Good Capex Ratio?

Growth capital expenditures and revenue growth are closely tied, as along with working capital requirements, capex is grouped together as “reinvestments” that help drive growth.

Hence, if growth capex is expected to decline and the percentage of maintenance capex increases, the company’s revenue should decrease from the reduction in reinvesting.

Barring unusual circumstances, it would be unreasonable over long-term time horizons for revenue growth to sustain itself (or increase) if the allocation of resources towards reinvestments has been decreasing.

The trend in the growth of capex must match revenue growth for projections to be reasonable.

As a company reaches maturity and the growth rate slows down to a sustainable rate (i.e., the company can grow at this rate perpetually), the ratio between depreciation and capex should converge towards 100%.

The convergence over time is attributable to how the majority of the spending becomes comprised of maintenance capex in tandem with the gradual diminishing of growth opportunities at some point in the lifecycle of the company.

Once a company’s growth begins to stagnate noticeably, a higher proportion of its total capex spend should shift toward maintenance capex.

In periods of economic expansion, the percentage of growth capex also tends to increase across most industries (and the reverse is true during periods of economic contraction).

How Do Capital Expenditures Impact the Financial Statements?

In terms of building a complete 3-statement financial model , taking the time to assess historical capital expenditure levels properly and projecting future capex accordingly is a critical step.

  • Income Statement (I/S) → In order to match the expenses with the associated revenues during the same period, the value of the acquired PP&E is expensed via depreciation on the income statement as opposed to being treated as a one-time, immediate cash outflow on the date incurred. The expenditure is thus spread across the asset’s useful life, which is an estimate of how long the asset is considered to be “useful” and capable of producing economic benefits.
  • Cash Flow Statement (CFS) → The actual full cash outflow related to capex is captured in the cash from investing section of the cash flow statement.
  • Balance Sheet (B/S) → On the assets section of the balance sheet, the capex amount will be captured as an increase to the PP&E balance and be reduced by the non-cash depreciation expense.

Capex vs. Opex: What is the Difference?

The difference between capital expenditure (Capex) and operating expenses ( Opex ) is as follows.

  • Capital Expenditure (Capex) → Capital expenditure refers to the purchase of a fixed asset (i.e. useful life assumption that exceeds 12 months) expected to provide long-term economic benefits. On the income statement, capex is capitalized and then expensed.
  • Operating Expense (Opex) : On the other hand, operating expenses (Opex), such as costs incurred from sales, marketing, or general day-to-day business operations, do NOT provide economic benefits over the long term (>12 months). Instead, the benefits from such expenses are near-term, which is why companies must continuously budget and allocate spending towards them, as opposed to periodic large outflows of cash.

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  • Capital Expenditures

capital expenditure in business plan

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

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Table of contents, what are capital expenditures (capex).

Capital expenditures or capital expenses are funds used by companies or businesses for the purchase, improvement, and maintenance of long-term assets.

These long-term assets must have a useful life of a year or more and are intended to enhance the efficiency of a business.

They are usually physical, fixed, and non-consumable assets such as property, equipment, or infrastructure. However, they can also include intangible assets such as a patent or license.

Capital expenditures are recorded on cash flow statements under investing activities and on the balance sheet , usually under property, plant, and equipment (PP&E).

Unlike operating expenses (OpEx), capital expenditures are not recorded in full during the period in which they were incurred.

Instead, they are deducted over time as a depreciation expense, starting the year after the item was obtained.

Types of Capital Expenditures

There are three types of business expenses recognized by the Internal Revenue Service (IRS) as capital expenditures. They are the following:

Business Startup Costs

Business startup costs are the initial funds spent on getting a business up and running.

For example, when a small company is looking to start a new business in a new city it may spend money on market research, feasibility studies, or environmental impact assessments.

Some business startup costs can be considered capital expenditures while others are counted as operating expenses.

Startup costs are categorized into capital expenditures or operating expenses, depending on how long it takes to recover each specific cost through future revenues.

Costs that are related to future revenues, such as buildings, patents, or machines, are typically considered capital expenditures.

Meanwhile, costs that are not related to generating future revenues, such as rent, advertising, or salaries, are considered operating expenses.

Business Assets

These are capital expenses made to acquire long-term assets that will be used in business operations.

This may include land, buildings, vehicles, furniture, office equipment, machinery, and franchise rights.

For instance, a company may purchase a fleet of vehicles to deliver its products.

The cost of the vehicles would be considered a capital expenditure since it is a long-term asset that will be used to generate income for the company.

Improvements

Improvements are capital expenses incurred to increase the value or prolong the useful life of long-term assets.

This may include activities such as replacing a major part of some equipment or making additions to an existing property.

For example, a company decides to renovate its office space so that it can be used by a new division.

In this case, the renovation cost would be considered a capital expenditure, since it will increase the value of the office space and prolong its useful life.

Formula for Capital Expenditures

The formula for calculating capital expenditures is as follows:

Capital_Expenditures_Formula

Property, Plant and Equipment

The formula above mentions Property, Plant, and Equipment.. These are fixed, tangible assets utilized by businesses to generate revenue and profit.

These typically include machinery, buildings, vehicles and land. When a company uses funds to purchase these items, they are recorded as part of the total PP&E on the balance sheet.

Depending on the nature of the business, most capital expenditures fall under the category of Property, Plant, and Equipment while some do not.

For instance, patents and licenses are intangible assets and thus not included in the PP&E category. Instead, they may have their own separate category in the balance sheet.

In cases like these, we can revise our formula to take into account the value of both the PP&E and the other intangible capital expenditures.

Depreciation

Capital expenditures are not deducted as an expense on the month in which they were incurred, instead, they are amortized or depreciated over the span of their useful life.

PP&E items are depreciated while intangible assets such as patents or licenses are amortized.

Depreciation is the periodical allocation of a tangible asset’s cost on the balance sheet. Amortization functions in the same way, but is more focused on intangible assets.

Depreciation and amortization are done because the value of most capital expenditures decreases over time, mostly through wear and tear.

In the formula above, depreciation is considered a factor in computing capital expenditures.

In cases where a company has purchased intangible assets as part of its capital expenditures, the formula may be modified to include both depreciation and amortization.

Sample Calculation of Capital Expenditures

To illustrate, let us determine the capital expenditure of XYZ corporation in 2021 using the information presented below:

XYZ_CORPORATION_(revised)

Taking the highlighted figures from the information above, the calculation would be:

CapEx = Current PP&E – Prior PP&E + Current Depreciation

=74,550.00 - 72,300.00 + 10,000.00

= $12,250.00

The resulting CapEx figure shows that in 2021, XYZ Corporation invested $12,250.00 in property, plant, and equipment.

Cash Flow to Capital Expenditures Ratio

The cash flow to capital expenditures ratio measures the ability of a company to purchase capital assets using the cash generated from its operations.

A high ratio reveals that a company has a lesser need to utilize debt or equity funding since it has enough cash to cover possible capital expenditures.

In contrast, a low ratio shows that a company may not have enough funds available to make capital purchases.

In cases like these, it may choose to take out a loan or postpone necessary expenses due to the lack of funding.

The cash flow to capital expenditures ratio is calculated by dividing the cash flow from operations by its capital expenditures. The formula is as follows:

Cash_Flow_to_Capital_Expenditures_Ratio_Formula

For example, let us say that a company has $200,000 in its cash flow from operations and spends $100,000 on capital expenditures. The cash flow to capital expenditures ratio would be 2.

Cash Flow to Capital Expenditures = $200,000 / $100,000 = 2

This indicates that for every $2 dollars of cash gained through its business operations, the company has previously allotted around $1 dollar for capital expenditures.

Based on this result, the company may choose to either increase or decrease the amount they spend on capital expenditures.

Regardless of which direction it chooses to go in, the company has more than enough cash from its business operations to fund any possible capital expenses, without raising capital through loans or selling of shares.

Importance of Capital Expenditure Decisions in Business

Capital expenditures play a key role in the growth and expansion of businesses.

By reinvesting funds back into the business, companies are able to acquire new assets, improve existing ones, and expand their operations.

However, the decision to start a project involving much capital expenditure must be carefully analyzed as it will have a significant impact on the financial position and cash flow of a company.

Below are a few other reasons why companies need to deliberate before deciding how much to spend on capital expenditure:

Irreversibility

Capital expenditures are mostly considered irreversible decisions because they involve a long-term commitment of resources.

Most assets acquired under capital expenditure cannot be easily reversed without incurring some loss for the business.

For example, after a company acquires a piece of equipment, it may be difficult to resell it at its original price.

This is because it would now be considered used equipment, which is less attractive to buyers than newer models.

In other words, capital expenditures are considered sunk costs, and businesses have to "sink or swim" with their decisions.

Substantial Initial Costs

Capital expenditures typically involve high initial costs.

For example, constructing a new building would require a large amount of upfront capital which may strain the company's financial resources.

When assets are put into use, they will gradually lose their value over time due to wear and tear, obsolescence , or changes in market conditions.

This is why it is very critical to evaluate during the initial stages whether an expenditure is justified.

For example, a company must weigh the pros and cons of investing in a new computer system that will have a useful life of five years.

The company must determine if the benefits of the new system would outweigh its costs after taking into account factors such as depreciation.

Long-Term Effects

Capital expenditure decisions can have life-long effects on businesses. Once a decision is made, it is very difficult and costly to change course.

For instance, if a company decides to build a new factory in a certain location, it would be very difficult and expensive to move the factory to another location if the original decision turns out to be wrong.

This is why it is very important for companies to carefully consider all options before making a capital expenditure decision.

Challenges of Capital Expenditures

Despite the many benefits associated with capital expenditures, there are also some challenges that come along with it. These include:

Unpredictability in Forecasting

It is not guaranteed that a company will achieve the expected results from its capital expenditures.

This is due to several factors that can affect the outcome of a project, such as economic conditions, changes in technology, and competition.

For example, a company may build a new factory expecting to increase production by 30%.

However, if the economy weakens or competition intensifies, the company may only see a 20% increase in production.

This is why it is important for companies to have a contingency plan in place in case the expected results are not achieved.

Measurement Difficulty

Measuring and estimating the costs and benefits of capital expenditures can be a complex and challenging task.

For instance, it may be difficult to determine how much revenue a new factory will generate or how much cost savings will be achieved from a new computer system.

There are also intangible results of capital expenditures that are difficult to measure, such as the impact on employee morale or the company's reputation.

Temporal Spread

The costs and benefits of capital expenditures are often spread out over a long period of time. This makes it more difficult to determine the true financial impact of a project.

For example, the full benefits of a new machine may not be realized for several years after it is purchased. This makes it difficult to estimate the discount rate and establish equivalence.

Best Practices for Efficient Capital Expenditure Budgeting

Budgeting for capital expenditures must be carefully planned and executed. Here are some of the best practices to ensure more efficient capital expenditure budgeting:

Sufficient Planning

The first step in efficient capital expenditure budgeting is to have a clear and concise plan.

The plan should include the company's goals and objectives, as well as the projects that will be undertaken to achieve these goals.

Project scope and details should be clearly defined. The plan should also include strategies to mitigate any risks associated with upcoming projects.

Providing Inputs Through a Bottom-Up Approach

Department heads are well aware of the needs of their respective departments. Thus, they should be given the opportunity to provide input on capital expenditure budgeting.

A bottom-up approach ensures that all relevant departments have a voice in the budgeting process, which increases the chances of a company's capital resources being used efficiently.

Separating Expenditure Budgets

It is important to have separate budgets for capital expenditures and operational expenses.

Doing so will ensure that the company's capital resources are properly allocated and used for their intended purpose.

It will also make it simpler to calculate the separate deductions involving each type of expense.

This is because tax deductions on operational expenses apply to the current year, while deductions on capital expenditures can be spread out over a period of time through depreciation or amortization.

Setting a Budget Limit

It is important to set a budget limit for capital expenditures. This will help ensure that a business does not overspend on projects and put itself at financial risk.

Forming Clear Policies

Capital expenditure budgeting should be based on clear and concise policies. These policies should be designed to achieve the goals and objectives of the company.

They must also be reviewed and updated on a regular basis to ensure that they are still relevant and effective.

Measuring CapEx Returns

Capital expenditures should be measured and monitored to ensure they achieve the desired results. Some of the ways to do this include hurdle rates, return on investment ratios, and payback periods.

Analyzing the results and returns from previous capital expenditures will also help companies make informed decisions about future projects.

Once the strengths and weaknesses of previous projects are identified, steps can be taken to improve the efficiency of future projects.

Capital expenditure budgeting is a critical task for any company.

By following the best practices mentioned above, businesses can ensure that their capital resources are used efficiently and effectively.

Capital Expenditures vs. Operating Expenses

Some people confuse capital expenditures with operating expenses.

Below is a comparison table highlighting the difference between the two:

Capital_Expenditures_vs._Operating_Expenses

The Bottom Line

Capital expenditures are defined as the costs of purchasing and upgrading fixed assets such as buildings, machinery, equipment, and vehicles.

In contrast, operating expenses are the costs of supporting the current operations, such as wages, sales commissions, office rent, and advertising.

Certain business startup costs, business assets, and improvements are the types of business expenses that can be considered capital expenditures.

Capital expenditures are important for any company as they represent the investments made in the future of the business.

Thus, it is important to follow best practices that ensure efficient capital expenditure budgeting. This includes formulating clear policies, measuring CapEx returns, and setting a budget limit.

By following these best practices and understanding the difference between CapEx and OpEx, companies can ensure that their capital resources are used efficiently and effectively.

Capital Expenditures FAQs

How are capital expenditures reported.

Capital expenditures are capitalized on the balance sheet as assets. They can also be reported as payments for property, plant, and equipment in a cash flow statement.

Is capital expenditure an expense?

Capital expenditures are reported and classified as fixed assets. They are then charged as an expense over their useful life using depreciation or amortization.

What is the capital expenditure formula?

Capital expenditures can be calculated using the following formulas: CapEx = Current PP&E – Prior PP&E + Current Depreciation or CapEx = Change in PP&E + Current Depreciation

What is the difference between capital expenditures and operating expenditures?

Capital expenditures are the costs of purchasing and upgrading fixed assets such as buildings, machinery, equipment, and vehicles. In contrast, operating expenses are the costs of supporting the current operations, such as wages, sales commissions, office rent, and advertising.

Is CapEx tax deductible?

No. Capital expenditures are not tax deductible. However, you can depreciate or amortize the cost of the asset over its useful life.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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CapEx Budgeting: 6 Smart Steps for Business Owners

Decisions about when and how much to invest in new equipment, property, vehicles, land, or technology, also known as capital expenditures or ‘CapEx,’ are critical aspects of running a business.

Capital-intensive industries like manufacturing, utilities, and telecommunications often have higher capital expenditures, hence the need for a thoughtful CapEx budget.

Ultimately, well-planned CapEx allows a business to pursue larger orders instead of missing out due to a lack of capacity or investment.

The dilemma is “when what and how much” – is “now” the right time? Is this the right equipment to buy? Does it make sense to purchase a new plant this year? Can the business afford it, and what happens if you don’t make the purchase now?

Investing in new equipment and updated technology can make a capital-intensive organization more efficient and profitable and may help to gain a competitive edge in a market over businesses that operate with older, slower systems.

On the other hand, capital expenditures are a source of risk and may not produce an immediate payoff or generate a return. New equipment or software tools require training, and additional capacity is a waste of money if the business doesn’t achieve an increase in orders.

Manufacturing executives that lack a robust process for analyzing their cash needs to support ongoing operations may overspend on CapEx, causing a liquidity crisis that may require deep cost-cutting, leading to other business problems.

And, if the economy slows, it may become difficult to pay for the new equipment with internally generated cash flow or to service a loan if the debt was used to help make the purchase. Overspending on CapEx often fails to deliver an adequate return on investment. 

How can business owners make wise choices for CapEx, making investments in the business that is effective and financially sound?

In this post, we describe six steps to improving your CapEx budget process so that you can balance the goals of staying competitive while keeping the business cash flow positive. Let’s get started.

1. Decide what assets to include in your CapEx budget by focusing on long-term goals

To help focus on long-term planning, begin by envisioning where your business will be in two to three years, then list the types of assets required to help you get there. Remember, this is a different process than creating an operating budget that addresses monthly (or operating) expenses.

There are several areas to consider when planning your long-term CapEx budget. CapEx assets can be anything from new equipment to expand capacity to a new software system to better manage inventory. 

Types of CapEx can include: 

  • Equipment and Machinery
  • Buildings or Storage Space
  • Computers and Servers
  • Vehicles 

2. Justify each item with specific metrics

After you've determined what CapEx assets you will need to reach your long-term business goals, the next step is to defend each item based on longer-term (yet realistic) objectives, not just your needs for the next 12 months.

For example- are you considering buying new equipment to double capacity, even if your market only grows by 7-8% annually?

Link each item on your list with measurable, quantifiable goals. For example: "This new equipment will allow us to increase capacity by x% using our existing workforce," or "we will be able to expand our ABC product Line, increasing revenues by Z% in the mid-Atlantic region."

Remember that in many cases, robust deployment of CapEx assets can lead to improved customer satisfaction and retention.

Assessing each expense with tangible KPIs will also help your organization thrive in the long run, e.g., "we will reduce defects by x% so that we can reduce customer complaints by y% and reduce refunds by z%.

Read More: Resource Allocation: How to Strategically Drive Company Growth

3. Include all associated costs and benefits

Building on steps one and two of your CapEx budget is the long-term cost of your CapEx budget item- as the actual cost of the asset is always more than the purchase price of the item itself.  

There are indirect costs (perhaps a yearly maintenance contract, new training requirements for employees, or expanded IT needs), as well as opportunity costs – you may have to suspend production while new equipment is being installed and switching to a new software platform or ERP may result in disruptive downtime. 

On the positive side, many CapEx assets may have knock-on benefits – a CapEx item intended to reduce product defects and improve customer service may also increase employee satisfaction, reduce turnover, and improve customer acquisition .

4. Go back to the principles of corporate finance

As the CEO, you should always know the true cost and ROI of your capital. CapEx is an investment you make in your business, and it should offer a positive “net present value,” or it doesn’t make sense to go forward.

While many businesses use a simple concept of a payback period (how long it will take for this investment to generate net cash flow that equals its costs), a more defendable approach is to assess whether a capital expenditure item offers a positive net present value to your business.

In other words, you should expect to earn a return on your CapEx, taking into account the new cash flows it generates in the future minus the cash outflows (upfront and ongoing) associated with the item, discounted at the cost of the capital you use to buy it. 

Related: Cash Flow 101: Tips for Management, Projection, and Long-Term Improvement

5. Analyze alternatives

Remember that there is always more than one way to accomplish a goal. Before you emotionally commit to a specific piece of equipment or new software package, put down the glossy brochures from the trade shows and brainstorm at least one alternative to what you think is the best approach to achieve the objective.

Remember, 'Business As Usual' is almost always an alternative – what would be the cost of continuing what you’ve been doing? That may be so “expensive” in terms of lost business, inefficiencies, and repairs that spending on CapEx becomes less “expensive” than initially thought.

6. Measure success after the fact

Lastly, don’t invest in CapEx just because you can. Take the time to do a thorough analysis that shows your capital expenditures will generate an adequate ROI for your business.

Capex should lead the way in reducing labor costs through automation, expanding your product offerings, addressing regulatory requirements, and improving product quality. Therefore, it is critical to analyze whether or not the item is delivering the benefits you had included in your cost-benefit analysis.

Make sure your management team is held accountable for monitoring the effectiveness of a new piece of equipment or system.

If the CapEx asset is not performing as intended, find out why – do your employees need more training? Is there a feature you need the vendor to modify to make it work for your particular situation? Remember that capital expenditures should not just be limited to replacing irreparable equipment– that point of view limits growth opportunities. New equipment and capital expenditures should do more than maintain your business “as is”; they should be used strategically to elevate your business. 

If you’re not sure how best to approach these analyses, G-Squared Partners can help. Contact us for a no-obligation discussion about how we can help your business take these six important steps.

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What are Capital Expenditures (CapEx)? A Complete Guide

The assets your organization chooses to invest its financial capital in can mean the difference between organizational success and failure. These investments — also known as capital expenditures — involve complex considerations involving budgeting, your organization’s project portfolio and industry-specific concerns. This complexity ensures that answering the question of where to make a capital expenditure is rarely easy. Should an oil and gas company open a new refinery or renovate an existing site? What about a construction firm evaluating which new piece of equipment will help them complete their next project most efficiently?

To make every dollar your company puts towards capital expenditures go as far as it can, organizations must effectively account for these variables by leveraging robust capital budgeting and planning software. They must also have a solid understanding of how to calculate capital expenditures. Let’s take a close look at these and other key factors behind making intelligent capital expenditure decisions.

What are capital expenditures?

Capital expenditures (CapEx) are investments used to maintain, purchase or upgrade many kinds of non-consumable assets. These assets typically have high up-front costs, but they often represent the means by which an organization generates revenue or supports its internal infrastructure.  CapEx funds may be used to replace an outdated vehicle or piece of machinery, upgrade an organization’s computers, repave a parking lot or pay for the construction of a new facility. While traditionally CapEx funds were only used to purchase physical assets, investments in IT infrastructure and other technologies are now also classified as capital expenditures. Physical assets acquired with capital expenditures typically depreciate over their service lives.

Capital expenditures are generally made to enable new projects or facilitate current operations. They represent long-term investments that have the potential to impact your company for weeks, months or even years afterwards. To ensure that the significant costs associated with capital expenditures don’t go to waste, organizations should take all the steps needed to maximize the chances of success for associated capital projects.

This starts with adopting an enterprise capital budgeting and planning solution . These platforms help navigate many of the hurdles associated with making effective expenditures. By integrating all project processes and data in a single place, the best solutions enable companies to align their capital expenditures with their project portfolio, available capital budget and overall business objectives. This allows companies to ensure these expensive, critical initiatives are actually moving them closer to their own vision of success. These platforms also let organizations more accurately evaluate potential CapEx scenarios and make changes to current investments to boost capital efficiency. For more insights on CapEx and how businesses allocate their resources, explore the Annual Capital Expenditures Survey (ACES) . ACES is conducted by the U.S. Census Bureau and gives an overview of the capital expenditures made by non-farm businesses operating within the United States. The report can help your company better understand the CapEx investment landscape, as well as industry-specific trends, to guide its own CapEx spending decisions.

Strategically invest your CapEx Budgets to prioritize

The projects that complement the rest of your portfolio.

Portfolio Management with EcoSys Request a demo of EcoSys

CapEx vs. OpEx

Capital expenditures are one-off investments in the future of your business, rather than recurring costs. This means they are recorded as assets on your company’s balance sheet, rather than as expenses, and cannot be immediately written off to reduce a company’s revenue like other business expenses. Capital expenditures are distinct from more common costs called operating expenses (OpEx). These are recurring payments that can be deducted from your income statement. They include utility costs, fuel, wages, accounting fees, taxes and interest paid on debt.

Due to their more frequent nature, OpEx decisions can often be made unilaterally by leaders at lower levels of an organization. In contrast, capital expenditures usually involve larger sums and play a key role in determining the overarching business strategy of an organization. This means that they must typically be made or approved at a company’s highest levels of leadership.

Types of capital expenditures

There are many types of capital expenditures, each serving a distinct purpose and involving unique considerations. Here are some of the most common:

  • Buildings . New structures can be used to manufacture products, store inventory, provide a workspace to employees and more.
  • Land . Typically, only land purchased for development is classified as a capital expenditure. If your business purchases land for speculative purposes, this expense may be categorized separately on your expense sheet. 
  • Computers . Computers and other devices support critical aspects of business operations, including reporting, communication, collaboration and managing logistics. 
  • Equipment . This category includes any machinery used for manufacturing, sorting, mining , or otherwise delivering products to buyers.
  • Vehicles . This type of CapEx includes vehicles used for any business purpose, like picking up customers or transporting goods . 
  • Furniture . All desks, chairs and other office furniture are classified as capital expenditures.
  • Patents . Although patents are not tangible assets, they represent a long-term investment produced by significant, and often costly, research and development efforts, which is why they’re considered capital expenditures.

Alternatively, organizations can classify various types of capital expenditures together according to their purpose:

  • Acquisition expenses . Capital expenditures are often used to acquire new assets, including machinery, buildings and vehicles.
  • Upgrade costs . Money allocated to upgrading existing assets also falls under the heading of CapEx.
  • Renovations . Renovating existing assets is a common CapEx investment and can be less expensive than buying an entirely new asset. This involves making payments to update and improve an asset, rather than costs spent to fix it after it breaks down.
  • Repairs . Of course, capital expenditures are also frequently used to repair assets when their function is impaired. This category doesn’t include routine maintenance, like replacing tires on a fleet vehicle or performing regular oil changes, which instead counts as operating expenses.
  • Adapting assets . CapEx funds can also be used to adapt an existing asset for an entirely new purpose. Retrofitting assets can be another effective way of minimizing costs while ensuring that your company’s needs are met.

Launching a new business . Starting a new business venture or acquiring an existing company is likely one of the largest — and most important — capital expenditures an organization will ever make, with great potential risks and rewards.

How to calculate capital expenditures

The formula used to calculate net capital expenditures is relatively straightforward:

ΔPP&E + current depreciation of assets = CapEx .

In this formula, “ΔPP&E” represents the change in property, plant and equipment – an aggregate reported value.  To determine the change, subtract the prior period value from the current period . This formula is most useful for determining CapEx as an outsider from public financial statements. Within your own organization, you would already have the amount you spent yearly on capital expenditures broken out in the budget. You would be more concerned with questions like how to finance and get the most value out of the expenditures going forward.

Capital expenditures are used in other calculations as well. These include those used to determine how much cash your organization has available for any equity shareholders and ratios used for analyzing organization financial health.

Why use CapEx planning and budgeting software?

Managing capital budgets and expenditures is a multi-year process that’s often complex and challenging. Long-term business success demands a strategy for effectively managing your capital expenditures and organizational budget to ensure that your expenditures align with your company’s immediate and future goals.

Implementing a robust capital planning and budgeting solution is the best way to maximize the value of your capital expenditures. Look for a platform that lets you build and manage annual capital spending plans, generate accurate forecasts for monthly spending plans and better communicate the benefits of proposed capital expenditures to company leadership and external stakeholders alike. The best capital planning and budgeting solutions also include comprehensive reporting tools, so organizations can establish performance baselines and capture progress snapshots to more effectively evaluate how well their capital plans are performing in the wild.

Ensure your platform integrates capital-related capabilities with features used to manage every level of a project portfolio as well. These include functions for portfolio planning and control, resource management and issue, change and risk management. With the ability to leverage connected data from across your company, you can achieve an unmatched level of strategic alignment, striking an ideal balance between short- and long-term goals, your annual budget and your other available resources. Organizations in the industrial space can also leverage asset investment planning (AIP) to optimize their capital plans. AIP leverages asset information from across enterprise asset management systems to predict how those assets will perform. Choosing a CapEx platform that includes AIP functionality helps your organization increase visibility into future asset needs, maximize resources used for asset maintenance and replacement and more effectively plan the projects that will maximize asset performance.

Make better-informed CapEx decisions with EcoSys TM

Your organization’s capital expenditure budget should be strategically invested to prioritize valuable projects that complement the rest of your company’s portfolio, supporting long-term growth. With a dynamic capital budgeting and planning solution like EcoSys, you can confidently make CapEx investment decisions. EcoSys is an enterprise project performance (EPP) platform, combining the ability to implement best practices for capital budgeting and planning, no matter what your organization’s current processes are, with features for effectively managing individual projects and your company’s entire portfolio once capital expenditures are made.

If you’re ready to rethink the way you manage capital expenditures and projects, contact Hexagon today.

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Ultimate Guide to Capital Expenditure (CapEx)

Ultimate Guide to Capital Expenditure (CapEx)

March 2, 2022 By Support from Fervent Leave a Comment

Capital Expenditure (aka CapEx) is an important figure to accountants, investors, entrepreneurs, and financiers alike. Here’s everything you need to know about it, including what it is, why it’s important, and how we calculate it.

Investors like to see consistent growth in a company, and you are probably seeking better ways to figure out which companies are achieving this growth.

There are plenty of stories in the media that convey a feeling that corporations exist to provide huge bonuses to executives, but the reality is that corporations exist to return value to shareholders and ensure growth over a long period of time.

So, how do corporations use the fruits of their labour to grow the business? One of the tools at a corporation’s disposal is called capital expenditure.

This will be your ultimate guide to capital expenditures so you understand what it is and how corporations use it on their earnings statements.

What Is Capital Expenditure (CapEx)?

Firstly, what exactly is Capital Expenditure?

Capital Expenditure (or “CapEx” for short) refers to expenditure for  capital items.

The terminology dates back to several decades ago, when types of expenditure were broadly classified into:

  • Revenue Expenditure (aka Revenue Expenses), and
  • Capital Expenditure (aka Capital Expenses)

Back then, expenses that related to the day-to-day operations of the business were dubbed “Revenue Expenditure”.

The thinking was that these expenses are necessary to generate revenue on a day-to-day basis.

It’s still called “Revenue Expenditure” in many parts of the globe, but many people also tend to call this type of expenditure an Operating Expenditure (or “OpEx”, Operating Expense).

They’re both essentially identical.

Capital Expenditure, on the other hand, relates to expenses for capital items.

Broadly speaking, this includes expenses relating to buying, updating, repairing, or improving a “non-current asset” (aka “fixed asset”).

In principle, CapEx relates to expenditure which allows a firm to generate revenues in the long run.

Without these expenses, firms will not be able to grow sustainably.

Another way to think of Capital Expenditure is that a company is buying something for the specific purpose of increasing its capital generation capabilities.

What Are the Types of CapEx?

CapEx includes a variety of items, though the best way to think of CapEx is that it involves buying or materially improving fixed assets like:

  • equipment, and
  • technology, for example.

Another good way to think of CapEx is that companies are reporting CapEx on most things that have a very long useful life expectancy.

  • Buildings and Property: this one is fairly straightforward since building and property almost always have a lengthy period of usefulness. Companies will purchase buildings and property for specific projects and are the most basic CapEx type.
  • Equipment Upgrades: upgrading and maintaining equipment is a critical part of continued capital generation. For that reason, these expenses are considered CapEx.
  • Computers and Hardware: as mentioned earlier, CapEx includes technology. Computers and hardware relating to computers are all used to generate capital, especially as our world continues to advance digitally. While the cloud is becoming more ubiquitous, many companies still maintain in-house networking hardware to support their business needs. The initial purchase is included in CapEx as are upgrades and maintenance.
  • Vehicles: Everyone knows that vehicles are depreciating assets, but we’ll revisit this concept in a bit. Vehicles are, in many cases, critical to performing work and generating capital, so their purchase and maintenance costs are included in CapEx.

Broadly speaking, all of these types of items – buildings and property, equipment, vehicles, etc – tend to be classified as “Property, Plant, and Equipment”.

We’ll touch on this further down.

For now, let’s think about how to calculate CapEx.

How to Calculate CapEx (Capital Expenditure)?

CapEx is calculated by using this formula:

In simple English, CapEx is simply the difference between current and previous PP&E, plus depreciation.

Put differently, CapEx is equal to the change in PP&E, plus depreciation.

Thus, the CapEx formula above can also be written as:

Let’s now consider the individual elements of the CapEx formula.

Property, Plant, and Equipment (PP&E)

Property, Plant, and Equipment (PP&E) represents the book value/accounting value of a firm’s land and buildings, vehicles, machinery, etc.

Importantly, it  excludes intangible assets like software, goodwill, patents, and trademarks.

This is true at least at the time of writing and has been true for several decades.

But, as the world evolves and accounting standards catch up, it’s  possible that at some stage, accounting standard setters and investors will begin to see the purchase and maintenance/upgrading of intangibles as part of CapEx.

For now, we’re going to put aside our spirations of better accounting standards. And think about where we can find PP&E.

PP&E is found on a company’s Balance Sheet (aka Statement of Financial Position).

Depending on the size of the company, and the accounting standards it’s following, you’ll either see:

  •  PP&E as an individual line item on the Balance Sheet, or
  • Individual components of PP& as separate line items on the Balance Sheet

If it’s the latter case, it’d be a simple case of adding the individual components of PP&E to come up with a final value.

In order to calculate CapEx, you must find the difference between the PP&E values of the current and previous reporting periods.

You would then add the depreciation for the year, which you’d get from the company’s Income Statement (aka Profit and Loss Statement).

RELATED: What is the P&L (Profit & Loss Statement)? How Does It Work?

Since we’re exploring the individual components of the CapEx formula however, let’s quickly go over depreciation, shall we?

Depreciation

Depreciation is an accounting convention that is broadly interpreted in two main ways:

  • It’s a way of “apportioning” the costs of non-current assets over their useful economic life (UEL).
  • It’s an accountant’s estimate for the loss in value of a non-current asset.

Strictly speaking, accountants will almost always describe depreciation in the former light (that it’s a way of  apportioning the costs of non-current assets over their useful economic life).

And that is the correct interpretation of depreciation.

It’s relatively harder for beginners to understand this interpretation, however.

That is why the second interpretation is often widely used/adopted.

It’s not  wrong per se. But, strictly speaking, it isn’t quite right, either.

For the purpose of calculating CapEx however, either interpretation will suffice.

The key takeaway is that depreciation is  added to the change in PP&E in order to calculate Capital Expenditure.

And as we said earlier, you’d find the value for depreciation in the company’s Income Statement.

Note that you  can also find it in a company’s Cash Flow Statement (aka Statement of Cash Flows).

But this depends on how the Cash Flow Statement is prepared and presented. For instance, some versions will start with Earnings Before Interest and Tax (EBIT), in which case they’d need to add back depreciation.

A Cash Flow Statement that starts with EBITDA on the other hand, wouldn’t need to do so. Thus, you would  not see a value for depreciation in that particular Cash Flow Statement.

CapEx vs OpEx

It’s important to remember that there are other categories of expenses. And oftentimes, people end up confusing capital expenditures with operating expenditures.

Operating expenditure, also known as “OpEx” or Operating Expense, are those expenses necessary for daily business operations, generally including anything with a useful life of less than a year.

These are also dubbed “Revenue Expenditure”, as we highlighted earlier in this article.

OpEx would include things like office supplies, utilities, travel, property insurance, and general repairs and maintenance of property, plant, and equipment (as long as it doesn’t increase the value of the PP&E).

Any expenditure that increases the value of PP&E is a Capital Expenditure.

OpEx is simply reported as operating expenses on the Income Statement (aka P&L). They’re simply are a cost of doing business.

A company may choose whether a particular expense should be CapEx or OpEx. It really depends on the business needs. One of the best modern examples of this situation is data storage and networking.

Many companies maintain their own internal network and storage in support of their data management.

Any spending on new server equipment and storage held in-house would be considered CapEx.

However, the cloud has allowed companies to opt for their networking to be leased from any of the major cloud computing companies like Microsoft with Azure or Amazon with AWS.

If a company’s networking is conducted in this way, the monthly cloud spend would be considered OpEx.

What Does CapEx Mean For Investors?

How a company spends its money is an important metric for all investors.

For that reason, CapEx is followed closely to see whether a company is actively investing in future growth.

Capital expenditures tend to be quite large when compared to OpEx.

Companies need to actively invest in CapEx in order to remain competitive and sustainable.

Thus, investors may see flat CapEx as an indication that the company is not making any new investments for future projects. Of course, as highlighted earlier, it also depends on how a company reports CapEx.

Remember that what shows up in a given financial statement is heavily influenced by accounting standards.

If the accounting standards are outdated or irrelevant, then so are the values that show up on financial statements that are the result of those redundant standards!

CapEx can be a bit vague from the perspective of an individual investor because corporate accountants can report CapEx in several different ways.

The company might be investing heavily in their IT future, but they may be using cloud-based services that are reported as OpEx.

Thus, it’s important for investors to analyse a company’s CapEx in conjunction with its other activities.

Comparing 2 companies CapEx by themselves is far from good analysis.

What’s Next – Capital Expenditure (CapEx)

CapEx is an important part of a company’s reporting for a number of reasons.

A corporation’s primary purpose is really to grow over a long period of time to maximise value for its shareholders.

CapEx can provide investors with an idea of how active a company is investing in that future value growth.

While companies may vary in the ways they report CapEx, you can learn how to track past trends in CapEx to obtain a better understanding of how a company is growing.

Learning and using  data-driven investing strategies  can pave the way for a robust application of CapEx for investors.

Hopefully, all of this makes sense.

That’s a wrap from us for now.

Keep learning, keep growing!

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Capital Expenditures (CapEx)

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What are capital expenditures (capex).

Capital Expenditures (CapEx) is the cash a company pays for capital assets that will deliver long-term value to the business. These capital assets usually consist of (1) PP&E and (2) Intangible Assets. PP&E are physical assets, such as buildings, office fixture, cash registers, machinery, etc. Intangible Assets are things like patents and software. Companies makes these spending with the intention of improving or expanding the business, increasing efficiency, or maintaining competitive advantage.

If a company spends $500 buying desks and chairs for its employees, it’d record the $500 as CapEx. Likewise, if a gas station spends $10,000 buying a new gas machine, it’d record the $10,000 as CapEx.

In most instances, companies spend Capital Expenditures mostly on physical assets, such as buildings, machineries, and equipment. A common misconception is that Capital Expenditures only include spending on physical assets. This is not true. Capital Expenditures are expenditures related to capital assets, which are assets that drive the company’s long-term growth. These capital assets may include both PP&E and Intangible Assets. Both PP&E and Intangible Assets enable the business to operate and generate value over the long-term. Therefore, Capital Expenditures include cash spent on both PP&E and Intangible Assets.

However, in practice, many companies spend most of their Capital Expenditures on PP&E. That’s because physical assets often require ongoing maintenance. As a result, in practice, CapEx mostly relate to spending on physical assets.

Capital Expenditures can be categorized into two main types: Growth Capex and Maintenance Capex . Growth CapEx are spendings to expand the business, such as opening new locations, launching new products, or upgrading technology. On the other hand, Maintenance CapEx are investments to maintain the existing business, such as repairing machinery or replacing equipment.

How CapEx Appears on Financial Statements

Capital Expenditures is a line item on the Cash Flow Statement. It usually appears as a cash outflow under Cash Flow from Investing. When companies spend cash to buy capital assets, they are making an investment. They are investing into their core business operations. Therefore, it’s categorized as an investing activity.

Companies that spent all of their CapEx on physical assets will call it “Purchases of Property, Plant and Equipment” or “Purchases of Physical Assets” instead of “Capital Expenditures”. Regardless, the terms are conceptually similar.

Here’s an example from Amazon ( 10-K page 36 ).

Capital Expenditures Example Amazon

Remember, CapEx is the cash the company spends on long-term assets. The long-term assets acquired through CapEx recorded on the Balance Sheet, usually in the line item “Property, Plant & Equipment”. These assets depreciate over their useful lives. Useful life is the estimated period of time that the asset will generate benefits for the company. The Depreciation expense is then recorded on the Income Statement and Cash Flow Statement as a non-cash expense.

Capital Expenditures are a key component of a company’s financial management as they can impact the company’s cash flow. Properly managing CapEx is important to ensure the company is investing in the right projects to drive growth and profitability.

Capital Expenditure Examples

Here are some CapEx examples.

Property: A company may invest in real estate to expand its facilities, build new locations, or purchase land.

Equipment: A company may invest in machinery or other equipment to improve production efficiency, increase capacity, or upgrade existing equipment. Examples of equipment include machinery, computers, phones, cash registers, shelves, etc.

Office Furniture & Fixture: A company may invest in things for the office, such as desks, chairs, sofa, conference call technologies, etc.

Technology: A company may invest in software, hardware, or other technology.

The above are some broad examples of CapEx. However, it’s equally important to understand what’s not considered CapEx. Purchase of other businesses is not a form of Capital Expenditure. That’s part of M&A. It’s recorded separately in a different line item on the financial statements.

Growth CapEx

Growth CapEx refers to capital expenditures made by a company to expand or grow its business. These investments are typically focused on increasing revenue, improving market share, or entering new markets. Here’s a real example of Growth CapEx made by Apple.

One of Apple’s recent Growth CapEx initiatives is the development of its own processors for use in its Mac computers. In 2020, Apple announced that it would transition from using Intel processors to its own Apple Silicon processors. The company claimed this would provide better performance and energy efficiency. This initiative required significant investment in R&D equipment, as well as changes to Apple’s supply chain and manufacturing processes.

Apple has also invested heavily in building new retail stores, which have become a significant source of revenue. The spending required to buy the furniture and fixtures required to fill the retail stores is part of Growth CapEx. In recent years, Apple has opened new retail locations in China, India, and other emerging markets. These investments in retail stores have helped Apple to grow its customer base and increase sales of its products.

Maintenance CapEx

Maintenance CapEx refers to capital expenditures made by a company to maintain, repair or replace existing assets. Companies make these spendings to ensure their businesses continue to operate and prevent downtime or failure. These investments are typically focused on maintaining the existing level of operations and are necessary for a company’s long-term success. Here’s a real example of Maintenance CapEx made by United Airlines.

United Airlines is a well-known example of a company that invested heavily in Maintenance CapEx. In 2020, United Airlines announced that it would invest $1 billion in its facilities over the next few years to upgrade and modernize its aircraft fleet.

One of the key initiatives that United Airlines is undertaking as part of this investment is the construction of a new widebody aircraft maintenance facility at its hub in San Francisco. The new facility will be capable of performing maintenance on up to six widebody aircraft at a time. Additionally, it will include state-of-the-art equipment and technology to improve efficiency and reduce downtime.

United Airlines is also investing in the maintenance of its existing aircraft fleet, which is critical to the airline’s operations. In 2020, United Airlines invested $300 million in engine maintenance and overhauls.

Overall, Maintenance CapEx is an essential component of a company’s strategy to maintain its assets and ensure their continued operation. Companies that invest wisely in Maintenance CapEx initiatives can minimize downtime and prevent unexpected failures. Without Maintenance CapEx, equipment’s natural wear and tear can have significant impact on a company’s operations and profitability.

Capital Expenditures vs. Operating Expenses

Capital Expenditures (CapEx) and Operating Expenses (OpEx) are two types of spendings that a company incurs in its day-to-day operations. The main difference between the two is in the nature and timing of the expenses.

Capital Expenditures are investments in long-term assets that are expected to deliver multi-year benefits into the future. Examples include purchasing property or equipment, developing new technologies, or expanding a production facility. Because CapEx delivers multi-year benefits, companies amortize it over the useful life of the asset.

On the other hand, Operating Expenses are the costs incurred by a company to maintain its daily operations. These spending typically provide benefit that last less than a year. For example, common OpEx include rent, salaries, marketing, utilities, and other day-to-day expenses.

Another key difference between CapEx and OpEx is how companies treat them for accounting and tax purposes. CapEx is a capital asset that appears on a company’s Cash Flow Statement and Balance Sheet. OpEx is a cost that appears on a company’s Income Statement. CapEx creates Depreciation or Amortization over its useful life. By contrast, OpEx is fully deductible in the reporting period for tax purposes.

Is Capital Expenditures Tax Deductible?

Yes, CapEx is tax-deductible. While CapEx is typically not fully deductible in the year companies make the spending, it is generally tax-deductible over the useful life of the asset.

For tax purposes, CapEx is typically treated as a capital asset. This means it’s subject to Depreciation or Amortization over its useful life, as determined by the tax code. The IRS established rules for how to calculate the useful life of various types of assets. Companies must use these rules to determine the amount of Depreciation or Amortization to deduct each year.

Therefore, the tax deductions in the form of Depreciation & Amortization for CapEx are spread out over several years. This can help to reduce the company’s taxable income in each of those years. Companies that made significant CapEx can offset Depreciation & Amortization against their taxable income.

However, tax treatment of CapEx can vary depending on the specific circumstances of the investment and each country’s tax code.

CapEx Formulas

Because CapEx is a number that companies report directly on the Cash Flow Statement, you don’t really need to calculate it. However, there are a few formulas related to CapEx you should know.

Capital Expenditures Formula

The first formula captures Capital Expenditures’ relationship with PP&E.

Previous Period PP&E + Current Period Capital Expenditures – Current Period Depreciation = Current Period PP&E.

This formula is used to calculate the total amount of capital expenditures made by a company during a specific period. It takes into account the ending and beginning balances of the company’s net property, plant, and equipment (PPE), as well as the depreciation expense incurred during the period.

The second formula captures Capital Expenditures’ relationship with Revenue.

Capital Expenditures / Revenue = CapEx as a % of Revenue

This formula calculates the percentage of sales that a company is investing in Capital Expenditures. It divides the company’s CapEx by its Revenue and measures the company’s capital intensity.

The third formula captures Capital Expenditures’ relationship with the expected benefits.

Capital Expenditures / Annual Incremental Cash Inflows = Payback Period

This formula calculates the time it takes for a company to recover CapEx through incremental cash flows from the CapEx. The shorter the payback period, the more economically attractive the investment.

How Do You Calculate CapEx?

Notice that none of the above formulas calculate CapEx per se. They all measure CapEx in relation to another metric, but none actually calculates CapEx itself.

That’s because CapEx is usually not a number companies calculate through a formula. It’s really based on however much they spend. For example, if they spent $50 buying an office desk, then CapEx is $50. If they spend $1,000 buying an office computer, then the CapEx is $1,000. A company’s total CapEx is the sum of all these investments in long-term assets.

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Capital Expenditure Plan Template

Capital Expenditure Plan Template

What is a Capital Expenditure Plan?

A Capital Expenditure Plan is a strategy for businesses to make strategic investments towards achieving long-term financial goals. It serves as a roadmap for businesses to identify, prioritize, and track capital expenses. The plan outlines the objectives, actions, and measures to be taken to ensure the efficient, effective, and accountable use of funds.

What's included in this Capital Expenditure Plan template?

  • 3 focus areas
  • 6 objectives

Each focus area has its own objectives, projects, and KPIs to ensure that the strategy is comprehensive and effective.

Who is the Capital Expenditure Plan template for?

The Capital Expenditure Plan template is designed for financial teams of all sizes and industries. It provides a comprehensive framework to create a plan that streamlines and simplifies the process of making capital expenditure decisions. This template is designed to help you maximize the return on your investments, while minimizing risk.

1. Define clear examples of your focus areas

Focus areas are the key areas of capital expenditure that need to be addressed. Examples of focus areas may include streamlining the capital expenditure process, improving capital expenditure budgeting, and enhancing capital expenditure documentation.

2. Think about the objectives that could fall under that focus area

Objectives are the goals that need to be achieved in order to accomplish the focus area. Examples of objectives may include reducing capital expenditure cycle time, increasing capital expenditure accuracy, and increasing capital expenditure budget accuracy.

3. Set measurable targets (KPIs) to tackle the objective

Key Performance Indicators (KPIs) are measures that are used to track the progress and performance of your objectives. These should be specific, measurable, and achievable. Examples of KPIs may include reducing capital expenditure cycle time from 14 days to 7 days and increasing capital expenditure accuracy from 78% to 98%.

4. Implement related projects to achieve the KPIs

Projects (actions) are the activities that need to be carried out in order to achieve the KPIs. Examples of projects may include automating the capital expenditure approval process and implementing capital expenditure tracking software.

5. Utilize Cascade Strategy Execution Platform to see faster results from your strategy

Cascade Strategy Execution Platform is a comprehensive platform that enables organizations to effectively plan and execute their strategies. Cascade’s powerful analytics and reporting tools provide real-time insights into your capital expenditure process, enabling you to make informed decisions and optimize the return on your investments.

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GMDC jumped after board OKs Rs 3,041 cr capex plan for FY25

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Capex Increased By 11.1% For FY25, Focus On Infra Development: Interim Budget FY25

Gmdc slides after q3 pat drops 56% yoy to rs 117 cr, zydus life q3 pat climbs 27% yoy to rs 790 cr; board oks rs 600 cr share buyback, hfcl hits 52 week high after board oks to set up ofc unit in poland, fy24 fiscal deficit revised down to 5.8% of gdp, fy25 target at 5.1%, fm says, kanak projects standalone net profit rises 59.52% in the december 2023 quarter, kamarhatty company standalone net profit rises 89.47% in the december 2023 quarter, teesta valley tea company reports standalone net loss of rs 3.64 crore in the december 2023 quarter, sensex climbs 535 pts; nifty hits fresh life high; vix drops 4.58%, olectra greentech bags order for supply of 2,400 electric buses.

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What Are Typical Examples of Capitalized Costs Within a Company?

capital expenditure in business plan

Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit.

In accounting, the cost of an item is allocated to the cost of an asset, as opposed to being an expense, if the company expects to consume that item over a long period of time. Rather than being expensed, the cost of the item or fixed asset is capitalized and amortized or depreciated over its useful life.

Typical examples of corporate  capitalized costs  are items of property, plant, and equipment. For example, if a company buys a machine, building, or computer, the cost would not be expensed but would be capitalized as a fixed asset on the balance sheet.

Other expenses associated with constructing a fixed asset can also be capitalized. These include materials, sales taxes, labor, transportation, and interest incurred to finance the construction of the asset. Intangible asset expenses can also be capitalized, such as trademarks, filing and defending patents, and software development.

Key Takeaways

  • When a company capitalizes costs, it effectively spreads them out over time.
  • This allows a company to avoid incurring a very large expense in the current period.
  • Accounting rules and IRS regulations define which costs can be capitalized and which cannot.
  • Costs can be capitalize typically relate to assets that will generate revenue or value over time, with their depreciation schedule matching the timing of their revenue generation.
  • Intangible costs and certain types of labor are allowed to be capitalized in addition to fixed, tangible assets.

Understanding Capitalized Costs Within a Company

To capitalize cost, a company must derive economic benefit from assets beyond the current year and use the items in the normal course of its operations. For example, inventory cannot be a capital asset since companies ordinarily expect to sell their inventories within a year.

Because capitalized costs are depreciated or amortized over a certain number of years, their effect on the company's income statement is not immediate and, instead, is spread out throughout the asset's useful life. Usually, the cash effect from incurring capitalized costs is immediate with all subsequent amortization or depreciation expenses being non-cash charges .

Expenses that must be taken in the current period (they cannot be capitalized) include Items like utilities, insurance, office supplies, and any item under a certain capitalization threshold. These are considered expenses because they are directly related to a particular accounting period. 

Capitalized Costs for Fixed Assets

Companies often incur expenses associated with the construction of a fixed asset or putting it to use. Such expenses are allowed to be capitalized and included as part of the cost basis of the fixed asset.

If a company borrows funds to construct an asset, such as real estate, and incurs interest expense , the financing cost is allowed to be capitalized. Also, the company can capitalize on other costs, such as labor, sales taxes, transportation, testing, and materials used in the construction of the capital asset. However, after the fixed asset is installed for use, any subsequent maintenance costs must be expensed as incurred.

Capitalized Costs for Intangible Assets

Companies are allowed to capitalize costs associated with trademarks, patents, and copyrights . Capitalization is allowed only for costs incurred to defend or register a patent, trademark, or similar intellectual property successfully. Also, companies can capitalize on the costs that they incur to purchase trademarks, patents, and copyrights.

Companies are allowed to capitalize on development costs for new software applications if they achieve technological feasibility. Technological feasibility is attained after all necessary planning, coding, designing, and testing are complete, and the software application satisfies its design specifications.

When a company cannot demonstrate a link between costs and future revenues, such costs must be expensed immediately. In the case of software development, any associated costs incurred prior to achieving technological feasibility are expensed. Research and development cost is another example of current expensing due to the high-risk profile and uncertainty of future benefits from such costs.

Each company's accounting department establishes its dollar-value threshold for what it considers an expense rather than a capitalizable cost.

What Is an Example of Capitalization in Accounting?

Say that a company purchases a large machine to add to an assembly line with a sticker price of $1 million. The company estimates its useful life is 10 years and that it will generate, on average, $250,000 per year in sales. As a result, the company does not include the $1 million expense on its books in the year that it was purchased; rather, it spreads out the capitalized cost over time according to a depreciation schedule .

What Expenses Are Supposed Be Capitalized Using GAAP?

Generally accepted accounting principles, or GAAP, allows costs to be capitalized only if they have the potential to increase the value or can extend the useful life of an asset.

What Is Capitalized Cost Reduction?

In the context of borrowing and lending, capitalized cost reduction refers to mechanisms that lower the overall cost of the loan. Typically, this comes in the form of an upfront down payment or mortgage points. For a car loan, a trade-in or cash rebate can also provide capitalized cost reduction.

What Is Capitalized Labor?

Most often, wage labor is expensed by a company as it is paid. However, certain labor is allowed to be capitalized and spread out over time. This is typically labor that is identified as directly related to the construction, assembly, installation, or maintenance of capitalized assets. This essentially attaches that specific labor expense with the capitalized asset itself. Common labor costs that you are capitalized include architects and construction contractors.

Cost and expense are two terms that are used interchangeably in everyday language. However, in accounting, the two terms are separate. A cost is an outlay of money to pay for a specific asset, whereas an expense is the money used to pay for something regularly. The difference allows for capitalized costs to be spread out over a longer period, such as the construction of a fixed asset, and the impact on profits is for a longer time frame.

capital expenditure in business plan

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