Capital expenditure – CapEx, for short -refers to all payments that are then capitalized when registered on the balance sheet. These expenditures go into business expansion rather than revenue.
It’s important to note that CapEx, and expenditure in general, isn’t the same as expenses. Expenses are usually regular investments made to generate revenue. Capital expenditure is less common, and it signifies a more prominent benefit for the company.
Expenses include salaries, production costs, rent, and similarly recurring spending. On the other hand, capital expenditure is both more costly (upfront) and significant. Examples of capital expenditure include land, equipment and machinery, new software, and even paying out big loans.
CapEx and capital improvement
CapEx and capital improvement are very similar processes. In fact, many can argue that capital expenditure usually results in capital improvement. That’s because capital improvement refers to structural change and improvements for property.
However, we must understand they’re not the same. Capital improvement affects the value of the property by itself. Companies and individuals can make capital improvements, and it’s not always for commercial purposes. Common examples of capital improvement include kitchen renovations or adding rooms to a building.
Not being the same doesn’t mean they’re not related. Building parking lots and building expansions count as capital expenditures resulting in capital improvement.
There’s a plethora of methods and formulas to calculate your capital expenditure, You can also calculate your CapEx indirectly, calculating your asset value along with their depreciation.
However, the most straightforward approach is to add up the amounts spent on said assets. The approach then compares this total against the value the company received for sold assets.
This formula’s result is your net CapEx.
How does depreciation interact with CapEx?
Capitalizing on expenditures counts as assets when recorded on your balance sheet. You also need to expense said asset, moving it on your income statement, if you wish to move it off your balance.
Regardless of the method you use to depreciate, your total depreciation will equate your net CapEx over time. That means that you can compare your CapEx with your depreciation to know your company’s asset growth.
CapEx and valuation
The effects of CapEx on valuation vary depending on how you use your CapEx. Certain capital expenditure categories, like annual maintenance, rarely contribute to a business’ profitability.
That being said, growth-oriented capital expenditures can also contribute to a company’s value.