What Are Capital Expenditures (CapEx)?

Capital expenditures (CapEx) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. CapEx is often used to undertake new projects or investments by a company. Making capital expenditures on fixed assets can include repairing a roof (if the useful life of the roof is extended), purchasing a piece of equipment, or building a new factory. This type of financial outlay is made by companies to increase the scope of their operations or add some future economic benefit to the operation.

KEY TAKEAWAYS

• Capital expenditures are payments made for goods or services that are recorded or capitalized on a company's balance sheet instead of expensed on the income statement.
• Spending is important for companies to maintain existing property and equipment, and to invest in new technology and other assets for growth.
• If an item has a useful life of less than one year, it must be expensed on the income statement rather than capitalized, which means it isn't considered CapEx.
• Unlike CapEx, operating expenses (OpEx) are shorter-term expenses used for the day-to-day operations of a business.
• Examples of CapEx include the purchase of land, vehicles, buildings, or heavy machinery.

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Capital Expenditures (CAPEX)

Understanding Capital Expenditures (CapEx)

CapEx can tell you how much a company invests in existing and new fixed assets to maintain or grow its business. Put differently, CapEx is any type of expense that a company capitalizes or shows on its balance sheet as an investment rather than on its income statement as an expenditure. Capitalizing an asset requires the company to spread the cost of the expenditure over the useful life of the asset.

The amount of capital expenditures a company is likely to have depends on the industry. Some of the most capital-intensive industries have the highest levels of capital expenditures, including oil exploration and production, telecommunications, manufacturing, and utility industries.

CapEx can be found in the cash flow from investing activities in a company's cash flow statement. Different companies highlight CapEx in a number of ways, and an analyst or investor may see it listed as capital spending, purchases of property, plant, and equipment (PP&E), or acquisition expense.

You can also calculate capital expenditures by using data from a company's income statement and balance sheet. On the income statement, find the amount of depreciation expense recorded for the current period. On the balance sheet, locate the current period's property, plant, and equipment line-item balance.

Locate the company's prior-period PP&E balance, and take the difference between the two to find the change in the company's PP&E balance. Add the change in PP&E to the current-period depreciation expense to arrive at the company's current-period CapEx spending.

Types of CapEx

Many different types of assets can attribute long-term value to a company. Therefore, there are several types of purchases that may be considered CapEx.

• Buildings may be used for office space, manufacturing of goods, storage of inventory, or other purposes.
• Land may be used for further development. Accounting treatment may different for land specifically held as a speculative long-term investment.
• Equipment and machinery may be used to manufacture goods and convert raw materials into final products for sale.
• Computers or servers may be used to support the operational aspects of a company including the logistics, reporting, and communication of operations. Software may also be treated as CapEx in certain circumstances.
• Furniture may be used to furnish an office building to make the space usable by staff and customers.
• Vehicles may be used to transport goods, pick up clients, or used by staff for business purposes.
• Patents may hold long-term value should the right to own an idea come to fruition through product development.

Formula and Calculation of CapEx

\begin{aligned} &\text{CapEx} = \Delta \text{PP\&E} + \text{Current Depreciation} \\ &\textbf{where:}\\ &\text{CapEx} = \text{Capital expenditures} \\ &\Delta \text{PP\&E} = \text{Change in property, plant, and equipment} \\ \end{aligned}​CapEx=ΔPP&E+Current Depreciationwhere:CapEx=Capital expendituresΔPP&E=Change in property, plant, and equipment​

Capital expenditures are also used in calculating free cash flow to equity (FCFE). FCFE is the amount of cash available to equity shareholders. The formula FCFE is:

\begin{aligned} &\text{FCFE} = \text{EP} - ( \text{CE} - \text{D} ) \times ( 1 - \text{DR} ) - \Delta \text{C} \times ( 1 - \text{DR} ) \\ &\textbf{where:}\\ &\text{FCFE} = \text{Free cash flow to equity} \\ &\text{EP} = \text{Earnings per share} \\ &\text{CE} = \text{CapEx} \\ &\text{D} = \text{Depreciation} \\ &\text{DR} = \text{Debt ratio} \\ &\Delta \text{C} = \Delta \text{Net capital, change in net working capital} \\ \end{aligned}​FCFE=EP−(CE−D)×(1−DR)−ΔC×(1−DR)where:FCFE=Free cash flow to equityEP=Earnings per shareCE=CapExD=DepreciationDR=Debt ratioΔC=ΔNet capital, change in net working capital​

Or, alternatively, it can be calculated as: 

\begin{aligned} &\text{FCFE} = \text{NI} - \text{NCE} - \Delta \text{C} + \text{ND} - \text{DR} \\ &\textbf{where:}\\ &\text{NI} = \text{Net income} \\ &\text{NCE} = \text{Net CapEx} \\ &\text{ND} = \text{New debt} \\ &\text{DR} = \text{Debt repayment} \\ \end{aligned}​FCFE=NI−NCE−ΔC+ND−DRwhere:NI=Net incomeNCE=Net CapExND=New debtDR=Debt repayment​

The greater the CapEx for a firm, the lower the FCFE.

Special Considerations

Aside from analyzing a company's investment in its fixed assets, the CapEx metric is used in several ratios for company analysis. The cash-flow-to-capital-expenditures (CF-to-CapEx) ratio relates to a company's ability to acquire long-term assets using free cash flow. The CF-to-CapEx ratio will often fluctuate as businesses go through cycles of large and small capital expenditures.

A ratio greater than 1 could mean that the company's operations are generating the cash needed to fund its asset acquisitions. On the other hand, a low ratio may indicate that the company is having issues with cash inflows and, hence, its purchase of capital assets. A company with a ratio of less than one may need to borrow money to fund its purchase of capital assets.