CapEx - Explained
What is Capital Expenditure?
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Table of ContentsWhat is Capital Expenditure?How is CAPEX Used?The Importance of CAPEXWhere to find CAPEX statementCapital Expenditure and Relative Value
What is Capital Expenditure?
Capital Expenditure (CAPEX) refers to a cash flow component of investment activities which is usually monitored by shareholders. It is the amount of financial resources that a company uses to purchase capital goods with the aim of expanding the operational scope of the company. Examples of CAPEX include building a new plant or buying vehicle fleets to improve production.
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How is CAPEX Used?
In the business world, CAPEX refers to the expenses incurred by a company to purchase capital goods in order to improve the status of the company through the purchase of new assets or by valuation of existing fixed assets. Buying new computers, office suppliers, or delivery vans are examples of CAPEX. Another meaning of CAPEX is the amount of cash that a company spends in keeping its assets stable and operational thereby influencing the overall output of the organization. In accounting, expenses are only regarded to as capital expenses once the existing assets start depreciating or accruing amortization costs. This is so because in accounting, every company should discount its fixed costs with depreciation and amortization against the life of an asset. It is also noted in accounting that precise expenses that cover investments are capitalized if they increase an asset value. The capitalized expense should be distributed throughout the life cycle of the asset.
The Importance of CAPEX
Companies use CAPEX as an indicator of the life cycle stage that an organization is at a particular time. When a company begins, the CAPEX is usually high since the company would need series of equipment goods for production. In case the company develops quickly, the CAPEX will be greater than the depreciations of the fixed assets, which is an indication of the rapid rising of capital goods. However, in the case that the CAPEX is lower than or similar to the depreciations, then the company is decapitalizing and would eventually decline.
Where to find CAPEX statement
Companies can obtain their CAPEX statements from the cash flow statement generated from investing activities. There are several ways that companies can name CAPEX line in their cash flow statements including:
- Capital expenditures
- Expenses of acquisitions
- Acquisitions of plant, property, and equipment
The amount of investment that a company requires is always dependent on the industry it is located. Companies in industries such as telecommunication, oil, public utilities industries, and manufacturing are always highly demanding for capital. It is important to note that capital expenditure (CAPEX) is NOT the same as operating expenses (OPEX). The later refers to the short-term costs needed to meet the current operating expenses for running a business. OPEX, unlike CAPEX, can be fully deducted from tax the same year that expenses occurred.
Capital Expenditure and Relative Value
Capital expenditure refers to the ratio of cash flow to capital expenditure. It shows a company's ability to purchase long-term assets using cash flow. When the ratio of cash flow to capital expenditure is less than 1, there is an insufficient cash flow to fund the acquisition of assets, and vice versa. Below is the formula for free cash flow: Free Cash Flow = Earnings Per Share (CapEx Depreciation) (1 Debt Ratio) - (Change in Net Working Capital) (1 Debt Ratio)OR:Free Cash Flow = Net Income - Net CapEx - Change in Net Working Capital + New Debt - Debt Repayment