What is Capital Expenditure: Definition of CapEx, Example, and Formula

Definition of capital expenditure (CapEx)

Capital expenditure (CapEx) refers to the money a company spends to buy, upgrade, or maintain long-term assets. These assets can include buildings, equipment, vehicles, land, technology, and anything else used to run or grow the business over time.

Unlike other business expenses, CapEx is capitalised, which means the cost is recorded as an asset and spread over time. It appears on the company’s balance sheet as a long-term investment rather than being immediately expensed on the income statement.

Investors and analysts look at CapEx to determine how much a company is investing in its physical assets for future growth.

Understanding capital expenditures (CapEx)

CapEx spending varies widely depending on the industry. Certain sectors, like telecom, energy, utilities, or manufacturing, are more capital-intensive and require a lot of ongoing investment in infrastructure.

You’ll usually find a company’s CapEx listed in the cash flow from investing activities section of the cash flow statement. It might also appear as:

• Capital spending
• Purchases of PP&E (Property, Plant & Equipment)
• Asset acquisitions.

Types of CapEx

CapEx can be divided into tangible and intangible assets, as well as growth or maintenance assets.

Tangible CapEx assets

These are long-term fixed assets used in daily business operations, including:

• Real estate, such as land or buildings purchased for company use
• Machinery and equipment used for production
• IT infrastructure, like computers or servers
• Vehicles, including company cars, trucks or delivery vans
• Furniture, including office desks, chairs, and other furnishings
• Acquisitions.

Intangible CapEx assets

These are non-physical investments that still bring long-term value, such as:

• Patents: Intellectual property used for product development
• Licenses: Rights to sell or use products and services over multiple years.

Maintenance CapEx vs. growth CapEx

Maintenance CapEx refers to any spending required to keep current operations running. This could include repairing broken equipment or making routine software updates.

Growth CapEx, on the other hand, is spending used to expand the business or increase future profits, such as opening a new office, launching new products, or expanding into a new market.

Formula and calculation of CapEx

You won’t always find CapEx directly listed in financial statements, but it can be calculated using data from the balance sheet and income statement. We share the formula and steps to calculate CapEx below.

Explanation of the CapEx formula

CapEx can be calculated using the following formula:

CapEx = ΔPP&E + Depreciation

Where:

• ΔPP&E = Change in Property, Plant & Equipment (from prior to current period)
• Depreciation = Depreciation expense from the income statement.

Steps to calculate CapEx

Now that you know the formula, let’s look at the process of calculating CapEx:

1. Find the company’s PP&E balance for the current and previous periods (from the balance sheet)
2. Calculate the change in PP&E (current PP&E - previous PP&E)
3. Add the depreciation expense from the income statement
4. The result is the estimated CapEx for the period.

Examples of CapEx calculations

Let’s say a company’s current PP&E is $5 million, their prior PP&E is $4.5 million, and depreciation is $300,000.

CapEx = ($5M - $4.5M) + $300,000 = $800,000

This means the company spent $800,000 on capital expenditures this period.

CapEx vs. operating expenses (OpEx)

CapEx is not the same as operating expenses, or OpEx. Below, we compare the differences between the two.

Definition and examples of OpEx

Operating expenses (OpEx) are the short-term, recurring costs required to run a business day-to-day. These include:

• Payroll and employee benefits
• Rent and utilities
• Software licenses and equipment leases
• Property taxes
• Business travel
• Interest payments

OpEx is fully tax deductible in the year it’s incurred and recorded directly on the income statement.

Impact on financial statements

CapEx impacts a company’s balance sheet and shows up as depreciation on the income statement over time. On the other hand, OpEx is reported entirely on the income statement in the period it’s incurred and directly affects operating profit.

Key differences between CapEx and OpEx

The table below outlines the key differences between a capital expense and operating expenses:

Examples of CapEx

The below examples are all considered capital expenditures:

• Property: Land, office space, warehouses, or factories
• Equipment: Vehicles, manufacturing machines, office tools
• Hardware: Computers, servers, phones
• Furniture: Desks, chairs, cubicles
• Software: CRM, ERP, cybersecurity tools
• Renovations: Remodelling facilities or refurbishing aging infrastructure
• Upgrades: Improving existing equipment to boost efficiency
• Acquisitions: Buying other companies or their assets
• Patents & licenses: Intangible assets tied to products or services

Different industries also have different CapEx needs. Some industry-specific CapEx examples include:

• Retail: New store fitouts, POS systems, display shelving
• Telecom: Cell towers, satellite
• Healthcare: Medical imagine machines, diagnostic tools

CapEx and depreciation

When a company makes a CapEx investment, it doesn’t expense the full cost right away but spreads it out over the asset’s useful life. This is known as depreciation.

How depreciation works with CapEx

Here’s how depreciation works with CapEx:

• The CapEx spending appears on the balance sheet as an increase in long-term assets (usually under PP&E)
• The value of the asset is then gradually reduced over time using depreciation, which reflects wear, usage, or obsolescence
• Depreciation expenses show up on the income statement, reducing taxable income each year the asset is in use

For example, if a company buys servers for $100,000 and expects to use them for five years, it could depreciate $20,000 each year. That $20,000 is recorded as an annual expense even though the full purchase was made in the first year.

CapEx on financial statements

Capital expenditures show up differently across a company’s financial statements.

Reporting CapEx on the cash flow statement

CapEx is reported in the cash flow from investing activities section. It appears as a negative cash outflow, since the company is using cash to invest in long-term assets.

Reporting CapEx on the balance sheet

Money spent on CapEx increases the value of a company’s PP&E on the balance sheet. For example, if a company buys machinery for $1 million, PP&E increases by $1 million. Over time, the value of these assets is reduced by depreciation.

CapEx and income statement

CapEx doesn’t appear directly on a company’s income statement – instead, it’s spread over time as a depreciation expense. This helps match the cost of the asset with the revenue it helps generate.

CapEx and free cash flow

CapEx also affects free cash flow (FCF), which measures how much cash a company has available after investments.

Free Cash Flow = Operating Cash Flow - CapEx

Companies with high CapEx might have lower near-term cash flow.

Importance of capital expenditures

Choosing how much to invest in CapEx is one of the most important financial decisions a company can make. Here are some reasons why CapEx is so important:

Long-term impact

CapEx decisions go on to influence a company’s operations for years. For example, today’s investments in new equipment or buildings will affect a company’s productivity and capacity in the future. This is why it’s important that CapEx planning aligns with a company’s long-term strategy.

Irreversibility

Unlike most other expenses, capital expenditures are hard to reverse without incurring losses. Many capital assets, like specialised machines or custom-built facilities, are built to meet a company’s specific needs and can’t be easily resold or repurposed.

High upfront costs

Capital expenditures usually come with high initial costs, especially in industries like manufacturing, telecom, utilities, or oil exploration. Even though these assets provide long-term benefits, the costs incurred upfront are significant and require careful budgeting.

Challenges with capital expenditures

Capital expenditures are large projects that can be complex to manage. Some common challenges include:

Prioritising projects

Companies that have limited capital must carefully choose which projects to fund. Trying to balance multiple projects while keeping them aligned with strategic goals can strain cash flow and impact a company’s financial obligations.

Budgeting & forecasting

CapEx projects often have long timelines – think about constructing a new facility or upgrading systems. This can make forecasting difficult, as longer time periods might come with market fluctuations, economic shifts, or unforeseen expenses.

Measuring performance

Tracking the return on investment (ROI) of CapEx can be tricky, especially when it comes to broad or indirect investments. For example, it can be hard to gauge the impact of buying new machinery unless it leads to a direct and measurable boost in productivity.

Managing risk

Changing regulations and technological obsolescence can make planning CapEx difficult. For example, a company might need to update aging infrastructure to maintain compliance – putting more strategic investments on hold.

Efficient capital expenditure budgeting practices

The complexity and long-term impact of CapEx makes efficient budgeting essential. Here are some best practices to help improve CapEx planning:

Structure the budget before you start

Define the scope, deadlines, and resource requirements before starting a project. Consider how much internal support you’ll need, whether it’s manpower, materials, or finances. Taking the time to form a detailed plan upfront can help you build an accurate budget and prevent scope creep.

Think long term

Decide early on how the asset will be funded. Will it be paid for with existing cash reserves or financed with debt? Think about the pros and cons of each option and how it will affect the company. This long-term outlook will ensure CapEx decisions align with company goals and cash flow needs.

Use a reliable budgeting software

Start using a reliable budgeting software from the very beginning of the project. Look for software that helps manage projections and generate reports so it’s easier to monitor performance over time.

Capture accurate data

Good budgeting depends on good data. To create a realistic budget, make sure you’re using up-to-date, reliable information when planning project costs and estimating timelines.

Use the right level of detail

Too much detail can slow down the process, while too little will make the budget vague and less useful. Try to find the right balance that can guide decisions without making the budget outdated by the time it’s finished.

Create clear policies

If multiple teams or departments are involved, clear policies can keep things consistent. Outline clear approval process and documentation requirements to keep the budget on track.