CAPEX Capital Expenditure
Capital Expenditure (or CAPEX) is money used to buy new assets or make capital improvements that extend an asset’s useful life, be it newly acquired buildings, land or equipment, as well as certain intangible assets like capitalized software development costs or patents.
Routine maintenance and repairs, while sometimes necessary, are generally classified as operating expenses, not CAPEX, unless they significantly extend the asset’s life beyond its original expectancy.
CAPEX can be calculated by adding together the annual change in Plant, Property and Equipment (PPE) and the current stated depreciation expense.”
Top Brokers For Stock Trading With CAPEX Strategies
How Is CAPEX Used?
This measure tells an investor how much a firm is investing in future productive capacity to maintain or grow the business.
These are typically very long-term decisions, often not easy to reverse and set the strategic road map for the company’s future performance.
High CAPEX can be a sign of corporate confidence in their future, as they often involve high initial costs, with potential benefits often spread out over several years.
Under IFRS IAS 16 (Property, Plant and Equipment), the accounting framework used by over 140 countries, an item is recognized as property, plant, and equipment when future economic benefits are probable and costs can be measured reliably. This same principle applies under US GAAP and is recognized across most national accounting frameworks.
Industry Variation
Capex amounts will vary across industries, with Transportation or Semiconductor companies for example being particularly capital intensive, as new projects are often extremely expensive.
Computer Software companies and service sector Industries generally have much lower levels of Capex, which reduces their capital intensity, making them appear much more operationally efficient. [This can be calculated via the formula: Capital Intensity Ratio = Total Assets / Total Revenue].
Value Of Using Capital Expenditure
There is a high degree of uncertainty as to the success or otherwise of CAPEX ventures.
Difficulties in measuring and thus evaluating the proposal arise from both the very long-term nature of the strategy, which makes establishing both the appropriate discount rate and a fair comparison of alternative options extremely hard.
While most capital projects have 5-20 year horizons, some major infrastructure projects can extend 30-40 years or longer, creating additional complexity in evaluating returns.
In addition, there is the possibility of cannibalisation of existing product sales to consider; others might have intangible benefits, such as improving worker morale.
Operational Expenditure
In contrast to Capital Expenditures, Operating Expenditures are much more certain, being those incurred in the normal course of their business, such as heating bills, telephone and internet expenses etc.
The difference between the two can be a matter of judgement, but the main criteria is that spending is considered capital expenditure (Capex), if the financial benefits go beyond the current fiscal year.
For tax purposes in the US, for example, Capex is typically not fully deductible in the year incurred but must instead be depreciated or amortised over the asset’s useful life, subject to local tax rules and possible accelerated depreciation regimes.
This in turn adds value to that asset , which can affect the future tax liability of the firm should that asset be sold at some point in the future.
A key distinction in CAPEX accounting is determining what qualifies as a capital improvement versus routine maintenance. According to ICAEW guidance on IAS 16, expenditures that extend an asset’s useful life beyond its original expectancy or materially improve its functionality are capitalized, while repairs that restore an asset to its original condition are expensed as operating costs.
Capital expenditures appear as cash outflows in the Investing Activities section of the cash flow statement while simultaneously increasing fixed asset values on the balance sheet.
For many companies, it is their choice which they use, but it can have implications for both current profits and future net asset values for the firm.