CAPEX Capital Expenditure

Capital Expenditure (or CAPEX) is money used by a company to buy, maintain or up-grade its fixed assets, be they newly acquired buildings, land or equipment.

It can be so classified if the funds are used to buy new assets or to repair existing ones, in order to extend their working life. It can be calculated by adding together the annual change in Plant, Property and Equipment (PPE) and the current stated depreciation expense.

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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.

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.

Some Infrastructure projects can have a 30–40-year horizon associated with them.

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, Capex cannot be deducted from profits in the year that it is incurred, but rather must be capitalised, or depreciated, over the assets’ useful life.

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.

Capitalised costs appear on the firm’s Balance Sheet, via the Cash Flow statement, (thereby reducing overall cashflow), whereas expensed items show up in the profit and loss account of that particular financial year.

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.