Updating and maintaining your business with the company's current operating income can be a tough job to do. The investor has to spend a lot of money on the already existing business. Therefore, they can use the capital expenditure funds to upgrade and maintain physical assets. In this article, we are going to explore what is capital expenditure and the basic formula for calculating CapEx.

What is Capital Expenditure?

Capital Expenditure can also be said as CapEx, which is a type of fund that is used by the company to maintain, update, and acquire physical assets. When a company is undertaking a new project or investment, it often uses capital expenditure.

Making expenditures on physical assets like property, plants, buildings, technology, or machinery of a company is an example of capital expenditure. This financial outlay is created by the company to increase the scope of operations and add some future economic benefits to the industry.

CapEx is believed as an important part of business for a company's growth. This fund is spent to invest in new property, plant, equipment, products, and technology. Although the capex does not appear on the income statement of the company, it still has a huge impact on the cash flow.

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How Capital Expenditure Work?

Capital expenditure determines how much a company needs to invest in the existing fixed assets and new fixed assets to maintain the growth of the company. CapEx is a type of capitalized expenditure that is not included in the income statement of the company.

However, it is shown on the balance sheet as an investment. When a company capitalizes an asset, it does not record the entire cost as an expense, however, it spreads the expense over the useful life of assets. This is how the total expense is divided over several years.

The amount of CapEx totally depends on the industry, and it can be huge if the industry is huge that needs high maintenance and updates. The CpaEx is shown in the investing section of companys cash flow statement.

Importance of CapEx

The importance of capital expenditure funds can be determined by the list of functions that are facilitated by CapEx.

• This fund facilitates the acquisition of fixed assets like property, machinery, and equipment.
• This expansion expense helps in improving facilities, building new infrastructure, and increasing its assets and production capacity.
• It facilitates to acquisition of more customers and increases the geographic reach of the company, so the company can produce even more to meet customer needs.
• It helps in setting up the organization with new property and new machinery.
• CapEx helps a company speed up its business operations and make the company more efficient by investing in its maintenance and updates.

Categories of CapEx

Capital expenditure is classified into two main categories which are:

Maintenance Capital Expenditure (Capex)

The capital expenditure that is required for the maintainace to continue the working stage of the operating industry. These expenditures are used in works like repairing broken equipment so that the current level of revenue and profit levels can be sustained. However, neglecting the replenishment may affect the operations, which would negatively impact the performance of the company.

Growth Capital Expenditure (Capex)

A type of capital expenditure discretely spent to acquire more customers and increase the geographic reach of the company. It involves new strategies related to the growth of the company and expanding to new areas, creating new products, and targeting a wide range of customers. These kinds of funds and strategies boost the revenue of the company beyond what they've achieved in the past years.

How to Calculate Capital Expenditure (CapEx)?

The formula for calculating CapEx is:

CapEx= PP&E + Current Depreciation

Where

• = Net change
• PP&E = Plant, property, and equipment costs
• PP&E = Net change in Property, plant, and equipment costs

The alternative formula for calculating CapEx is:

FCFE= EP (CE D) * (1 DR) C * (1 DR)

Where:

• FCFE is equal to Free Cash Flow to Equity
• EP is equal to Earnings per share
• CE is equal to CapEx
• D is equal to Depreciation
• DR is equal to Debt ratio
• C is equal to Net capital, change in net capital

Examples of Capital Expenditure

The purchase of new fixed assets and repairing, or upgrading existing physical assets of a company are included in CapEx.

• Properties like Lands, Offices, and Buildings.
• Equipment like Machinery, Office Desks, Chairs, and Transportation Vehicles.
• Hardware like Computer systems, Laptops, and Mobile Phones.
• IT-related stuff like Cybersecurity, Infrastructure, ERP, and CRM.

Should you capitalize or Expense?

You will have to make the decision on the base of how long the benefit will last for that spending. If you expect the benefit longer than a year then you should capitalize it as an asset on the balance sheet. However, if the expected benefit is less than a year then go directly for the expense on the income statement.

You can understand the above statement with the help of this example:

Suppose you are going to buy office supplies like printer ink and paper. This will be an operating expense of the office and will be written on the income statement instead of the statement that represents cash flow as an investing activity. On the other hand, if you buy a building for the company, it would count as a capital expenditure because it will benefit the company for more than a year.

Conclusion

Capital Expenditures are the purchases made by the company to facilitate a company, to build new infrastructure, and to increase its assets and production capacity. It helps the company to expand to new areas and capture more of the market. The aim of these purchases is to boost the company's revenue beyond past years. We hope this article includes all the information on what is Capital Expenditure and how you can calculate it.