Capital Expenditure

Capital expenditures are funds used by the management company or active partners to acquire, improve or maintain a property. Often referred to as ‘CapEx’. Specifically applied to funds improve the useful life of a property.

What is Capital Expenditure?

Capital expenditure (often referred to as CapEx) is the amount that a company spends to purchase and maintain long term physical assets such as property, technology, equipment, vehicle etc. As this is an expenditure for capital, it is reflected in the balance sheet instead of the income statement., and is considered as an investment for the company instead of an expense. Capital expenditure is important for companies to maintain their daily operations and grow. 

What are the types of fixed assets in capital expenditures?

Capital expenditure involves spending money on fixed assets which last more than one year. This means they are long-term resources for the company. Now, there are two types of fixed assets:

• Tangible assets: These are physical assets that can be touched. Examples of tangible assets are a new property or building, company vehicles, laptops, computers, heavy machinery, etc. 
• Intangible assets: These assets are resources that cannot be physically touched yet they have monetary value. Examples include purchasing trademarks or copyrights, franchises, goodwill, patents, etc. ‍

What type of investment are capital expenditures?

Capital expenditures are considered as long term investments that last more than a year. This is not a one time investment as companies need to continuously spend money on acquiring new assets, maintaining the current ones and upgrading the existing ones. 

What is the formula for calculating capital expenditure?

Capital expenditure is the total amount that company spends on fixed assets like PP&E, i.e., Property, Plant & Equipment. The formula for CapEx is the sum total of net change in PP&E and the depreciation expense in a given year. So, the formula for CapEx is:

CapEx = Net Increase in PP&E + Depreciation Expense‍

What are the steps to calculate capital expenditure?

The steps to calculate CapEx are:

1. Find out the PP&E value at the beginning of the year and at the end of the year from the asset side of the company’s balance sheet.
   Net increase = PP&E at the end of year - PP&E at the beginning of year
2. Then, collect the accumulated depreciation at the beginning of the year and at the end of the year from the balance sheet.
   Depreciation expense = Accumulated depreciation at the end of year - Accumulated depreciation at the beginning of the year
3. Finally, you can calculate the CapEx of a year by applying the formula:

            CapEx = Net Increase in PP&E + Depreciation Expense ‍

When do we capitalize an expenditure and when do we  consider it as an expense?

To decide if the money spent on resources is an expense or a capital expenditure you can find out how long the benefit of that spending will last. If the benefit lasts for more than a year, it is considered as a capital expenditure and is capitalized as an asset in the balance sheet. On the other hand, if the benefit lasts less than a year, it is considered as an expense and is expensed directly on the income statement. 

For example, if you purchase a car to help your sales team visit clients, it will be considered as a capital expenditure because the asset is going to help the employees and will last more than a year. 

On the other hand, if you purchase bundles of printing sheets and pens, it will be considered as an expense or an operating expense. 

Conclusion

Capital expenditure is a necessary investment that companies need to maintain and upgrade their business operations. It also helps the company to grow as the expenditure is made on assets that will ultimately result in the profitability of the company. Financial analysts and investors tend to pay more attention to CapEx as they do not initially appear on an income statement but have major effects on the cash flow. 

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