What are capital expenditures – CapEx?
Capital expenditures, commonly known as CapEx, are funds used by a business to acquire, modernize and maintain physical assets such as real estate, buildings, an industrial plant, technology or equipment.
CapEx is often used to undertake new projects or investments by the company. Capital expenditures on capital assets can include everything from repairing a roof to building, purchasing equipment, building a brand new factory. This type of financial expenditure is also made by companies to maintain or increase the scope of their operations.
In other words, CapEx is any type of expense that a company capitalizes or displays on its balance sheet as an investment, rather than on its income statement as an expense.
The formula for CapEx is
TheCapEx=ΔPP & E+Current depreciationor:CapEx=Capital expenditureΔPP & E=Change in property, plant and equipmentTheThe
Capital expenditure (CAPEX)
How to calculate CapEx
If you have access to a company’s cash flow statement, no calculation is necessary. Find the company’s capital expenditures in the Cash flow from investing section of the company’s cash flow table.
You can also calculate capital expenditures using data from a company’s income statement and balance sheet. On the income statement, find the amount of depreciation recorded for the current period. On the balance sheet, find the balance of property, plant and equipment for the current period.
Locate the balance of tangible capital assets from the previous period of the business and take the difference between the two to find the change in the balance of tangible capital assets of the business. Add the change in property, plant and equipment to the depreciation expense for the current period to arrive at the CapEx expenses for the current period of the business.
What does the CapEx metric tell you?
Capital expenditure should not be confused with operating expenditure (OpEx). Operating expenses are short-term expenses required to cover the current operational costs of operating a business. Unlike capital expenditures, operating expenses can be fully deducted from corporate taxes in the same year in which the expenses were incurred.
CapEx can tell you how much a business invests in existing and new fixed assets to maintain or grow the business. In accounting terms, an expense is considered a capital expense when the asset is a newly purchased asset or an investment that has a useful life of more than one year or which improves the useful life of an existing asset. Expenses for items such as equipment that have a shelf life of less than one year, according to IRS guidelines, should be expensed on the income statement.
If an expense is a capital expense, it must be capitalized. This forces the business to spread the cost of expenses (the fixed cost) over the useful life of the asset. If, however, the expense is the one that keeps the asset in its current state, the cost is generally deducted in full in the year the expense is incurred.
CapEx can be found in the cash flow from investing activities in a company’s cash flow statement. Different companies highlight CapEx in several ways, and an analyst or investor can see it as a capital expenditure, purchases of tangible capital assets (tangible capital assets), acquisition costs, etc. The amount of capital expenditure that a business is likely to have depends on the industry it occupies.
Some of the more capital-intensive industries have the highest levels of capital spending, including petroleum exploration and production, telecommunications, manufacturing and utilities. For example, Ford Motor Company, for the fiscal year ended in 2020, incurred $ 7.46 billion in capital expenditures, compared to Medtronic which purchased PPE worth $ 1.25 billion for the same exercise.
Key points to remember
- A capital expenditure is a payment for goods or services recorded or capitalized on the balance sheet instead of being expensed in the income statement.
- CapEx’s expenses are important to businesses in order to maintain existing tangible capital assets and invest in new technologies and other assets for growth.
- If an item has a useful life of less than one year, it must be expensed in the income statement rather than capitalized.
Example of capital expenditure use
In addition to the analysis of a company’s investment in its fixed assets, the CapEx measure is used in several ratios for the analysis of the company. The cash flow to capital expenditure ratio, or CF / CapEX ratio, refers to the ability of a business to acquire long-term assets using free cash flow. The ratio of cash flows to capital spending will often fluctuate as businesses go through cycles of capital spending, large and small.
A ratio greater than 1 could mean that the company’s operations generate the liquidity necessary to finance its asset acquisitions. On the other hand, a low ratio may indicate that the company has problems with cash inflows and, therefore, its purchase of capital assets. A business with a ratio of less than one may need to borrow money to finance the purchase of capital assets.
CF in CapEx is calculated as follows:
TheCF / CapEx=CapExCash flow from operationsTheor:CF / CapEx=Cash flow to capital expenditure ratioTheThe
Using this formula, Ford Motor Company’s CF / CapEx is as follows:
The$seven.46 Billion$14.51 BillionThe=1.94TheThe
Medtronic’s CF / CapEx is as follows:
The$1.25 Billion$6.88 BillionThe=5.49TheThe
It is important to note that this is an industry-specific ratio and should only be compared to a ratio derived from another company that has similar CapEx requirements.
Capital expenditures can also be used to calculate free cash flow (FCFE) for a business with the following formula:
TheFCFE=EP–(THIS–re)×(1–DR)–ΔVS×(1–DR)or:FCFE=Free cash flow in equityEP=Earnings per shareTHIS=CapExre=DepreciationDR=Rate of endettementΔVS=ΔNet capital, change in net working capitalTheThe
Or, alternatively, it can be calculated as:
TheFCFE=OR–NCE–ΔVS+North Dakota–DRor:OR=Net revenueNCE=Net CapExNorth Dakota=New debtDR=Debt repaymentTheThe
The higher the capital expenditure of a business, the lower the free cash flow to equity.