They say you have to spend money to make money, and that's especially true in business. But spending isn't just the answer - you need to be investing in the right things, from the activities that keep your lights on today to the long-term expenditures that help you grow in the future.
Capital expenditures, also known as CapEx, are investments that support business growth over time. Building a new warehouse, expanding manufacturing facilities, and improving technology are all examples of CapEx activities that help businesses grow, increase their margins and expand their bottom line.
What is Capital Expenditure?
When a company purchases assets for use in the production of goods and services, these are often considered capital expenditures.
Unlike operating expenses (OpEx), capital expenditures typically provide economic benefits to the company over longer periods of time as opposed to covering day-to-day operational resources and expenses. CapEx is also reflected differently on the financial statements.
Because capital expenditures are often some of the largest investments the business makes, rather than showing up as an expense on the income statement, they are capitalized on the balance sheet and then depreciated over time.
Examples of capital expenditures include:
- Purchases of new property or buildings
- Purchases of major items with long life spans
- Purchases of equipment or machinery used in manufacturing
- Expenditures for research and development activities
Examples of costs that are not capital expenditures:
- Raw materials to produce goods and services
- Utilities including power and water
- Salaries and labor costs
- Insurance
How is capital expenditure different from operating expenses?
Operating expenses are short-term expenses that don't have a significant impact on the long-term growth of the company. OpEX is still vital to the success of the business - they include expenses for rent, SaaS services, utilities, and salaries.
While operating expenses are those that you continue to pay each month, capital expenses are long-term investments in a company's infrastructure or assets. This type of expense can be made through new equipment, technology, or real estate purchases. Over time, these expenditures should pay for themselves and continue to generate return for the business.
Why is investing in capital expenditure good for business?
An investment in capital expenditure is an investment in the future of the business. When a business is investing in expansion, evolving their products and quality, and making sure that they are doing all they can to stay on top of any technological advancements, it shows they are planning for growth.
Investments in capital expenditure tend to have a positive effect on the future performance of the company because the investments will lead to higher margins and increased bottom-line growth over time.
With longer life spans, experts often say that it's better to invest with a larger upfront cost than to continue to invest small amounts over time. This is because the return on investment can be faster with a large initial expense, and it also ensures that you are getting maximum value out of your assets by using them for as long as possible.
How to Calculate CapEx
There are two ways to calculate CapEx for a period of time: direct calculation or indirect calculation.
To do a direct calculation, you’ll need the following information
- Amount spent on asset 1
- Amount spent on asset 2
- Amount spent on asset 3
- Any additional amounts spent on assets
- Value received for assets that were sold
CapEx = Amount spent on Asset 1 + Amount spent on Asset 2 + Amount spent on Asset 3 – Value received for assets that were sold.
Example:
- Asset 1: $5,000
- Asset 2: $10,000
- Asset 3: $7,000
- Value received for assets that were sold: $5,000
CapEx = $5000 + $10,000 + $7,000 - $5,000 = $17,000
To calculate using the indirect method, you’ll need the following information:
- Current period depreciation
- Current period property, plant & equipment (PP&E)
- Previous period PP&E
CapEx = PP&E (current period) – PP&E (prior period) + depreciation (current period)
Let’s look at an example:
- 2020 Depreciation: $20,000 (current period)
- 2020 PP&E: $45,000 (current period)
- 2019 PP&E: $40,000 (previous period)
Capital Expenditure = $45,000 - $40,000 + $15,000 = $20,000
What can we learn from CapEx?
We can learn about certain aspects of a company's future when they are increasing their capital expenditures. This means that the company sees opportunities in their future to make more money in an expanding market. When companies invest in capital expenditures there is usually a positive return on investment over time.
A business with higher expenditure has higher margins and increased bottom-line growth rates. When a company invests in something it usually means they are investing in the future, investing in expansion, evolving their products and quality, accommodating changes in demand, etc.
Whereas operating expenses only have short-term effects, investments made for capital expenditure have long-term effects because they lead to higher margins and increased bottom-line growth rates over time with a longer life span.
Companies that invest in capital expenditures tend to have a positive effect on the future performance of the company because these investments will lead to higher margins and increased bottom-line growth.
Causal can help you calculate and track capital expenditure for your own organization or one you may be considering investing in. Pull data in from around the business and build dashboards in Causal to help the business see the return on investment for these long-term investments with clarity.
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