What Is Capital Expenditure? (With Definitions And Examples)

By Indeed Editorial Team

Published 4 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Businesses make several investments in new assets, such as buildings or machinery. Companies calculate the capital expenditure to analyse how much money they are spending and which investments are viable. Capital expenditure helps businesses distinguish between assets that are profitable and those making a loss. In this article, we answer, 'What is capital expenditure?', discuss how it differs from revenue expenditure, explain its formula, share its uses and provide an example to demonstrate how to calculate it.

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What is capital expenditure?

Knowing the answer to, ‘What is capital expenditure?' can help you understand why it is crucial for business accounting. Capital expenditure or CapEx is the money that a business spends to buy, maintain or improve its physical assets like property, plants, buildings, technology and machinery. Capital expenditures on fixed assets include repairing buildings, purchasing a piece of equipment, purchasing land or building a new factory. Companies make this type of financial expenditure to increase their operations or improve efficiency. Companies also calculate capital expenditure to show investors that they are continuing to maintain or grow their business.

Capital expenditure adds to the company's valuation and is an asset in the balance sheet as it increases the company's tangible assets. Companies usually list it in the cash flow statement under the section ‘Investment in Plant, Property and Equipment'. The amount capitalises in the balance sheet and then amortises or depreciates over several years. CapEx also includes repairing or upgrading an existing asset to increase its value or life, restoring a property or starting or buying a new business.

Here is a list of items that qualify as capital expenditure:

  • Buildings and real estate: All real estate purchases towards setting up a new office, production facility, warehouse or manufacturing unit.

  • Equipment upgrade: Upgrading the capacity of existing machinery and equipment to increase its performance or output.

  • Digital investment: Adding new digital devices, like computers, or upgrading software systems to strengthen data security.

  • Vehicles: Purchasing vehicles and other transport for business purposes.

  • Intangible assets: In some special cases, investments made to procure licenses, permits or patents are also a part of capital expenditure.

Related: Revenue Accounts: With Definition, Types And Examples

How is capital expenditure different from revenue expenditure?

Revenue and capital expenditure differ from each other in several ways. Capital expenditure includes long-term expenses by a business to purchase, upgrade and maintain physical assets like property, buildings or manufacturing facilities. These are typically one-time large purchases of fixed assets for revenue generation over a long period of time. These are not expenses but an addition to assets and add to the value of the company in the balance sheet.

Revenue expenditures are usually ongoing operating expenses. These are the short-term expenses required to run the daily operations of the business. These generally incur in the current fiscal and businesses may calculate them monthly, quarterly or annually. Revenue expenditures are essentially the same as operating expenses. They also include the ordinary repair and maintenance costs that are necessary to keep an asset running without necessarily improving or extending its life or usefulness. Revenue expenditures are usually recurring expenses as compared to the one-off nature of capital expenditures.

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How to calculate capital expenditure

Businesses generally add capital expenditure to the cash flow statement. You can also derive it from the income statement and balance sheet. Here is the formula to calculate the capital expenditure:

Capital expenditures = PP&E (current fiscal period) - PP&E (last fiscal period) + depreciation (current period)

In this formula, PP&E stands for property, plant and equipment, which appears as a line item in the balance sheet. This includes the fixed and tangible assets of the company.

If the company's cash flow statement of a business is available, then no calculation is required to determine the capital expenditure. You can easily see the capital expenditures made in the investing cash flow section of the balance sheet. In case you do not have access to the cash flow statement, you can compute the net capital expenditure if the business includes depreciation in its income statement. You can follow these steps to calculate capital expenditure:

1. Check the company's financial statements

To calculate capital expenditures, get the company's financial documents for the past two years. As the formula requires the PP&E values from two fiscal, it is essential to obtain them for two years. This will give you the values to calculate the capital expenditure of the company.

2. Subtract fixed assets

First, subtract the fixed assets in the financial statement from the previous year. These are the fixed assets listed for the financial year that has just ended. This helps determine any change in fixed assets. Next, reduce intangible assets since capital expenditure only uses tangible asset expenditures. It is essential to avoid any investments that the company received through that reporting period's acquisitions.

3. Subtract accumulated depreciation

Next, delete the previous financial year's accumulated depreciation from the accumulated depreciation for the year that has just ended. The formula for accumulated depreciation is:

Accumulated depreciation: (Asset cost - expected salvage value) / expected years of use

This gives you the total depreciation of the company's assets.

4. Add total depreciation

Once you make the deductions, add the depreciation to the change in fixed assets. This gives you the total capital expenditure for the period you are measuring. Companies use this formula to calculate capital expenditure and undertake financial planning or forecasting.

Related: What Is Fixed Cost Formula? (Definition And Examples)

Uses of capital expenditure

Capital expenditure has a significant influence on a company's long term and short-term financial performance. Many companies maintain historical capital expenditure records to show investors that they continue to invest in growing and expanding business operations. This figure indicates how much a company invests in existing and new assets to increase or maintain its business. Financial planners use the CapEx formula in financial modelling, mainly when working with large companies. CapEx also helps calculate several critical ratios for economic analysis. Besides, calculating capital expenditure can help businesses gain insight into future investments and avoid financial losses.

For example, the cash flow-to-capital expenditures (CF-to-CapEx) ratio shows the organisation's ability to acquire long-term assets using free cash flow. The CF-to-CapEx ratio usually fluctuates as businesses go through cycles of large and small capital expenditures. A ratio greater than 1 shows that the company is generating the cash it requires to fund its asset acquisitions. A lower ratio indicates that the company has a cash flow problem, which can create issues while purchasing capital assets. A company with less than 1 CF-to-CapEx ratio may have to borrow money to fund its asset purchases.

Related: How To Calculate Variable Cost In 3 Steps (With Examples)

Professionals involved in calculating capital expenditure

Here is a list of financial professionals involved in calculating the capital expenditure of a business:

  • Asset manager: Corporate asset managers calculate the capital expenditure to maintain a record of all business assets, investment, depreciation, returns and losses.

  • Accountant: Chartered accountants or company secretaries usually calculate the capital expenditure while creating balance sheets and tallying the company's financial records.

  • Financial analyst: Financial analysts may calculate the capital expenditure to create financial models, calculate risk, project future growth and help businesses make the right investment decisions.

  • Investment advisor: Investor advisors and bankers may calculate the capital expenditure of a company while giving investment advice to their clients on which companies can witness growth in the future.

  • Business analyst: Business analysts may determine the capital expenditure of their organisation or competitors to measure performance, investment and growth projections. They may also calculate to compare business operations before a merger or acquisition.

Capital expenditure example

Calculating the capital expenditure is important to grow, analyse, track and maintain new assets, equipment, products and technology. Here is an example of how to calculate capital expenditure:

Say in 2020, a business invested money on new equipment and computers to expand their operations. Here is some other important financial information related to the business:

Depreciation = ₹100,000

PP&E at the beginning of 2020 = ₹400,000

PP&E at the end of 2020 = ₹500,000

Here is how you can calculate the company's capital expenditures for that year:

Step 1: You can calculate the capital expenditure by subtracting the PP&E value at the beginning of 2020 (₹400,000) from the PP&E at the end of 2020 (₹500,000). This gives you a change in PP&E of ₹100,000.

Step 2: Next, add this value to the depreciation expense (₹100,000).

So, during 2020, the capital expenditure for the business is ₹200,000.

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