What is (CapEx) Capital Expenditure?
Capital Expenditure (CapEx) Definition
For accounting purposes, any expense that either adds new physical assets to a company or extends the life of an existing physical asset by more than one year is recorded as a capital expenditure.
Define CapEx in Simple Terms
The formula for Capital Expenditure is as follows:
CapEx = PP&E + Current Depreciation
Where PP&E is the change in property, plants, and equipment.
To find the change in PP&E, just take a company’s prior recorded PP&E, which can be found on the balance sheet, and subtract the current value from that.
Add the current-period depreciation expense to arrive at the CapEx value.
What Does Capital Expenditure Mean In Finance?
Capital expenditure should not be confused with operational expenses, which are funds required to sustain basic company operations.
Payroll, purchasing office supplies, rent on buildings, and other funds not related to doing business are OpEx, not CapEx.
A company’s CapEx tells you how much the company is investing in new assets to expand the scope of its business.
Since different industries can require very different amounts of CapEx to keep the business moving, the values are highly variable.
Companies in the oil industry, for example, require huge amounts of CapEx to pay for expensive oil rigs and drills, not to mention funds spent on exploring for new sources of oil.
Therefore, investors tend to focus on how a specific company’s capital expenditure compares to direct competition in the same industry.
Capital expenses are funds invested into assets that increase productivity or take on new initiatives.
Because these expenses are considered investments, the business does not incur the expense all in year one, but rather incurs the expense spread across the useful life of the asset. For example, a building might have a useful life of 27.5 years.
A company that purchases a new building won’t record the entire cost being incurred at the same time, but will split the cost into 27.5 pieces and incur a fraction of that cost each year.
This means that a company capitalizes these expenses, showing them on their balance sheet as investments as opposed to on their income statement as expenditures.
The value of a capital expenditure is recorded as a part of a company’s assets, and the value decreases each year through depreciation.
A function of the cost of capital expenditures being spread out over the useful life of an asset is that it prevents large one-time expenses from skewing the data on a balance sheet.
By smoothing out these expenses, it gives investors a more accurate picture of the actual state of a business.
Investors will often look at the ratio of a company’s cash flow to their CapEx.
Cash flow is the amount of money that a company has left after paying the expenses required to maintain and expand a business.
A ratio of above 1 usually indicates that the company has plenty of free cash to spend on all the capital expenses they need. For example, a company’s CF/CapEx ratio might be $20 billion / $10 billion, for a ratio of 2.
A high CF/CapEx ratio often indicates that a company is operating efficiently, although it could also mean that the company is under-investing in their assets.
A ratio close to 1 could indicate that a company is struggling to meet the cash flow requirements to invest in capital expenditures, which means that they don’t have the free cash to easily grow.
A ratio below 1 means that the company does not even have the profit required to maintain operation, and is losing money.
What else can CapEx be used for?
Capital expenditure can also be used to calculate free cash flow to equity, which measures how much equity is available for shareholders after expenses, debt, and reinvestment costs are all paid.
To get this value, use the equation FCFE=EP-(CE-D)*(1-DR)-C*1-(DR) where FCFE stands for “free cash flow to equity,” EP is “earnings per share,” CE is “CapEx,” D is “depreciation,” DR is “debt ratio,” and C is the “change in net capital.”