What is a capital expenditure (CAPEX)?
A capital expenditure (CAPEX) is an investment in a business, such as manufacturing equipment, office supplies, or a vehicle. A CAPEX is generally geared towards the goal of deploying a new line of products or expanding a company’s existing operations.
Money spent on CAPEX purchases is not immediately reported to an income statement. Rather, it is treated as an asset on the balance sheet, which is deducted over several years as a depreciation charge, starting with the year following the date the item is purchased.
Understanding Capital Expenditures (CAPEX)
CAPEX and income statement
Each year in which this depreciation charge is recognized in the income statement effectively reduces a company’s profit. To cite an example, if a flower shop owner purchases a delivery van for $ 30,000, that vehicle is recorded as an asset on the balance sheet in the same year, but that year’s income statement is not affected by the ‘purchase.
Key points to remember
- A capital expenditure (CAPEX) is an investment in a business, such as manufacturing equipment, office supplies, or a vehicle.
- A CAPEX is generally geared towards the goal of introducing a new product line or expanding a company’s existing operations.
- Money spent on CAPEX purchases is not immediately reported to an income statement.
Suppose further that the store owner plans to use the van for six years, where the vehicle depreciates by $ 5,000 annually. In these circumstances, the income statement for the following year would show an expense of $ 5,000.
As a reminder: a CAPEX does not directly affect the income statements in the year of a purchase, but for each following year for the expected useful life of the asset, the depreciation charge affects the income statement.
Free Cash Flow and CAPEX
Although CAPEX is often presented in the cash flow statement, it is very important to understand all the components. For this, an investor can calculate the CAPEX of a period with the following formula:
CAPEX=EARvs–EARp+OFor:EAR=Plant, property and equipmentEARvs=PPE for the current periodEARp=PPE from the previous periodOF=Depreciation expense
Essentially, CAPEX reduces free cash flow, which is calculated as operating cash flow minus CAPEX. However, CAPEX is considered an investment, used to buy or improve an existing asset.
There are often purchases linked to a CAPEX, which in fact immediately impact an income statement, depending on the type of asset acquired. Using the example of the flower shop, although the purchase price of the van is not recorded in the income statement for that year, incidental costs such as bills for gasoline, car insurance and ” vehicle maintenance are considered as professional expenses, which would appear on the company’s income statement.
However, it should be noted that these expenses can be offset by the increase in income that could potentially result from increased business activity, due to the increased delivery capacity.
CAPEX versus operating expenses
While CAPEX refers to money spent on tangible assets that will be used for more than twelve months, operational expenses refers to money spent on regular operations of a business.
While CAPEX investments appear on the cash flow table under the investment section, operating expenses appear on the income statement as expenses, with the corresponding amount appearing on the balance sheet, either as a reduction in cash or as an increase in the accounts. suppliers.