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CapEx vs OpEx: Differences, Formulas, and Calculation
Every business incurs expenditures since making money requires spending money. These expenses are essential for driving growth, maintaining operations, and generating revenue. Business success depends on strategic spending, whether it's for staffing, marketing, product development, or infrastructure. As an investor, you want to know what a company is spending on to make sure you agree.
For the accountants of those businesses, these can be categorised as Capital Expenditures (CapEx) and Operating Expenses (OpEx).
For the accountants of those businesses, these can be categorised as Capital Expenditures (CapEx) and Operating Expenses (OpEx).
QUOTE
Never take your eyes off the cash flow because it’s the lifeblood of business.
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- CapEx is concerned with large one-off purchases for long-term value, while OpEx is concerned with recurring operating expenses.
- OpEx typically includes costs for items with a lifespan under 12 months, such as rent, salaries, and utilities. These are the day-to-day expenses necessary to keep the business running. On the other hand, CapEx covers longer-term investments like buildings, machinery, and vehicles - assets that provide value over a period greater than 12 months.
- CapEx is not immediately tax-deductible, as it is capitalized and deducted over time through depreciation and/or amortization, while OpEx is fully tax-deductible in the year it is incurred, reducing taxable income immediately.
What are Capital Expenditures (CapEx)?
DEFINITION
CapEx is the money you invest today to build your empire for tomorrow. It's the cost of making long-term investments that will drive future growth, such as purchasing assets like equipment, property, or technology. These expenditures are important for expanding and strengthening the business over time.
In order to grow, companies need to make investments. This might include the purchase of a new roof, vehicle or piece of equipment. These are long-term fixed assets and are recorded on the company’s balance sheet, not the income statement. Without such expenditures, firms would be unable to grow.
Analysts follow a company’s CapEx closely as it can impact cash flow and indicate whether or not the company is investing for the future. Large investments are associated with long-term growth but also lower short-term profitability. This is the trade-off that companies need to get right to be both sustainable and grow.
Analysts follow a company’s CapEx closely as it can impact cash flow and indicate whether or not the company is investing for the future. Large investments are associated with long-term growth but also lower short-term profitability. This is the trade-off that companies need to get right to be both sustainable and grow.
How CapEx works
CapEx is used for items that last for one year or more. This includes machinery, equipment, land, buildings, etc. It can be located on a company’s balance sheet under the term investing activities.
When an asset has been capitalised it loses value over time due to depreciation, which is where things lose value over time as they get worn out or become less effective relative to newer alternatives. In the majority of cases, capital expenditures are the largest expenditure for companies. CapEx also includes some types of intellectual property.
CapEx can be externally financed. A company can issue bonds (a form of loan) to raise capital for a particular investment or it can issue new shares. Hence these activities collectively are known as the capital markets.
Note that as a general rule of thumb, a company that pays dividends to shareholders and invests significantly in CapEx is viewed as safe and dependable, with good long-term growth potential.
When an asset has been capitalised it loses value over time due to depreciation, which is where things lose value over time as they get worn out or become less effective relative to newer alternatives. In the majority of cases, capital expenditures are the largest expenditure for companies. CapEx also includes some types of intellectual property.
CapEx can be externally financed. A company can issue bonds (a form of loan) to raise capital for a particular investment or it can issue new shares. Hence these activities collectively are known as the capital markets.
Note that as a general rule of thumb, a company that pays dividends to shareholders and invests significantly in CapEx is viewed as safe and dependable, with good long-term growth potential.
How to calculate CapEx
Calculating CapEx involves determining the funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment. The formula to calculate CapEx is:
FORMULA
CapEx = PP&E (current period) – PP&E (prior period) + Depreciation (current period)
PP&E stands for Property, Plant, and Equipment.
PP&E stands for Property, Plant, and Equipment.
To calculate CapEx, you take the ending PP&E balance from the balance sheet, subtract the beginning PP&E balance, and add the depreciation expense for the period. This calculation provides the total amount spent on physical assets during a specific period.
Financial reporting of CapEx
CapEx is reported on the balance sheet under the assets section as part of Property, Plant, and Equipment. These expenditures are capitalised, meaning they are recorded as assets rather than immediate expenses that would appear on the P&L statement (known as the income statement in the US), and then depreciated over their useful lives.
Depreciation expense appears on the P&L statement, reflecting the allocation of the cost of these assets over time.
In the cash flow statement, CapEx is listed under cash flows from investing activities, showing the actual cash outflow used to purchase or upgrade the company's physical assets.
Depreciation expense appears on the P&L statement, reflecting the allocation of the cost of these assets over time.
In the cash flow statement, CapEx is listed under cash flows from investing activities, showing the actual cash outflow used to purchase or upgrade the company's physical assets.
Types of CapEx
CapEx can be further broken down into more detailed components to give investors a more granular view of where money is being allocated.
1. Expansion CapEx
Expansion CapEx refers to the funds used by a company to grow its existing operations or enter new markets. This can include purchasing new equipment, building new facilities, or acquiring other businesses. The goal of expansion CapEx is to increase the company's capacity, output, or market presence, ultimately driving revenue growth.
2. Replacement CapEx
Replacement CapEx involves spending on replacing existing assets that are no longer efficient or have reached the end of their useful life. This type of expenditure ensures that the company maintains its current operational capacity without significant downtime. Examples include replacing old machinery, upgrading technology systems, or renovating ageing infrastructure.
3. Compliance CapEx
Compliance CapEx represents the investment required to meet regulatory requirements and standards. This includes expenditures necessary to comply with environmental regulations, safety standards, or industry-specific laws. For example, a manufacturing company might need to invest in new equipment to reduce emissions and comply with environmental laws.
4. Strategic CapEx
Strategic CapEx involves investments made to achieve long-term strategic objectives. This can include entering new markets, developing new product lines, or investing in technology that provides a competitive edge. These expenditures are usually part of a broader strategic plan aimed at positioning the company for future growth.
What are Operating Expenses (OpEx)?
DEFINITION
OpEx relate to expenses incurred by a business as a result of daily activity, in order to maintain its daily operations. This includes costs such as utilities, payroll, insurance, rent, and similar ongoing expenses. These are typically tax-deductible, helping to reduce a company's taxable income.
Whether an expense is deemed OpEx or not differs from industry to industry. While management will seek to keep OpEx as low as possible, these are essential to core operations so they cannot be reduced to the point where it impacts the quality of service provided to users.
How OpEx works
OpEx is reported on a company’s P&L statement, which has several categories of expenses, some of which count towards OpEx and some of which don’t - see the breakdown below:
Count as OpEx:
- Selling, General & Administrative (SG&A) Costs: These cover business operations like marketing, administrative salaries, and office expenses.
- Research & Development (R&D): Typically treated as OpEx but can also be considered CapEx depending on the project stage and accounting treatment.
- Depreciation & Amortisation: Though non-cash expenses, they represent the allocation of long-term asset costs and are counted as operating expenses.
Don't count as OpEx:
- Cost of Goods Sold (COGS): Categorized under gross profit, not part of operating expenses.
- Interest Expenses: Classified under financial expenses, not OpEx.
- Taxes: Reported as a separate line item, outside of operating expenses.
- Extraordinary Expenses: One-off, non-operating items that don’t count as OpEx.
- Other Non-Operating Expenses: Any costs unrelated to core business operations are excluded from OpEx.
Operating expenses can also be either fixed or variable expenses. A fixed operating expense does not change over the course of a year or years, such as rent or salaries. In contrast, variable expenses can change, such as the production costs for a given quarter.
How to calculate OpEx
To calculate OpEx, sum up all the expenses related to the day-to-day activities of the company. These typically include salaries, utilities, rent, office supplies, maintenance, and other operational costs.
FORMULA
OpEx = Salaries + Rent + Utilities + Supplies + Maintenance + Other Operating Costs
Calculating OpEx is straightforward as you simply add all the expenses together. By accurately calculating OpEx, businesses can understand their cost structure and identify areas for potential savings or where more impetus should be put.
Financial reporting of OpEx
Operating Expenses are reported on the income statement. They are deducted from revenue to determine the operating profit, which is an indicator of a company's profitability.
OpEx is divided into the categories listed above like selling, general, and administrative expenses (SG&A). Detailed reporting of OpEx helps stakeholders understand the company's spending patterns and operational efficiency.
OpEx is divided into the categories listed above like selling, general, and administrative expenses (SG&A). Detailed reporting of OpEx helps stakeholders understand the company's spending patterns and operational efficiency.
Types of OpEx
Just like with CapEx, there are many subcategories of operational expenses to account for:
- Salaries and wages - salaries and wages are one of the largest operating expenses for most businesses. This category includes payments to employees for their work, including benefits, bonuses, and payroll taxes.
- Rent and utilities - rent and utilities are essential operating costs for any business that leases space. Rent covers the cost of using office or retail space, while utilities include electricity, water, gas, internet, and phone services. These costs are usually fixed.
- Office supplies and equipment - office supplies and equipment are necessary for day-to-day operations. This includes items like paper, pens, computers, and other office necessities. While these expenses may seem minor individually, they can add up over time.
- Maintenance and repairs - maintenance and repairs are ongoing expenses needed to keep equipment and facilities in good working condition. This includes routine upkeep, as well as unexpected repairs.
- Marketing and advertising - marketing and advertising expenses are incurred to promote the business and attract customers. This can include online ads, print media, social media campaigns, and promotional events.
- Travel and entertainment - travel and entertainment expenses are often necessary for business development and client relations. This includes costs for business trips, client meetings, meals, and accommodations.
- Insurance - insurance is an important operating expense that provides protection against various risks. This can include general liability insurance, property insurance, and employee health insurance.
- Professional services - professional services include payments for external expertise, such as legal advice, accounting, consulting, and IT support. These services provide specialised knowledge and skills that may not be available in-house.
Key differences between CapEx and OpEx
Some expenditures clearly fit in one vs the other, for example long-term assets such as buildings and machinery are almost always CapEx, while rent, utilities and salaries are almost always OpEx.
CapEx vs OpEx
There are many expenses that fit somewhere in the middle and their categorisation will depend on generally accepted accounting principles, as well as rules determined by the company and their accountants.
For example, if a small business purchases a new printer for £100, the printer is expected to last over one year, making it an asset that could be depreciated as CapEx. However, given its relatively small value, it could alternatively be treated as an immediate expense and counted as OpEx. The decision depends on the company's accounting policies and materiality threshold.
The following describe the different ways these two sets of expenditures are treated:
For example, if a small business purchases a new printer for £100, the printer is expected to last over one year, making it an asset that could be depreciated as CapEx. However, given its relatively small value, it could alternatively be treated as an immediate expense and counted as OpEx. The decision depends on the company's accounting policies and materiality threshold.
The following describe the different ways these two sets of expenditures are treated:
1. Timing and duration of benefits
The timing and duration of benefits from CapEx and OpEx differ significantly.
CapEx provides benefits over a long period, as it involves purchasing or upgrading physical assets that contribute to the business's operations for several years. For example, a new manufacturing plant or advanced machinery can improve production capabilities for many years.
In contrast, OpEx covers expenses that benefit the company in the short term. These are recurring costs necessary to maintain daily operations, such as office supplies or monthly software subscriptions.
CapEx provides benefits over a long period, as it involves purchasing or upgrading physical assets that contribute to the business's operations for several years. For example, a new manufacturing plant or advanced machinery can improve production capabilities for many years.
In contrast, OpEx covers expenses that benefit the company in the short term. These are recurring costs necessary to maintain daily operations, such as office supplies or monthly software subscriptions.
2. Financial statement treatment
CapEx is recorded as an asset on the balance sheet and then depreciated over its useful life. This depreciation expense is gradually written off each year, reducing the asset's value on the balance sheet.
OpEx, however, is recorded as an expense on the income statement in the period it is incurred. This immediate expense reduces net income for that period but does not affect the balance sheet significantly, except through cash outflow.
OpEx, however, is recorded as an expense on the income statement in the period it is incurred. This immediate expense reduces net income for that period but does not affect the balance sheet significantly, except through cash outflow.
3. Tax implications
CapEx and OpEx have different tax implications.
CapEx is not immediately tax-deductible. Instead, the expense is spread out over several years through depreciation or amortisation, depending on the asset type. This gradual deduction can reduce taxable income over the asset's useful life.
OpEx is fully tax-deductible in the year it is incurred, providing an immediate reduction in taxable income. This can be advantageous for companies looking to lower their tax liabilities in the short term.
CapEx is not immediately tax-deductible. Instead, the expense is spread out over several years through depreciation or amortisation, depending on the asset type. This gradual deduction can reduce taxable income over the asset's useful life.
OpEx is fully tax-deductible in the year it is incurred, providing an immediate reduction in taxable income. This can be advantageous for companies looking to lower their tax liabilities in the short term.
4. Risk and return considerations
CapEx investments usually carry higher risk and return considerations. Since these expenditures involve significant upfront costs and long-term commitments, they can impact a company’s financial flexibility.
If the investment does not yield the expected returns, it can lead to financial strain. However, successful CapEx investments can significantly boost productivity and profitability. OpEx, being more flexible and adjustable, generally involves lower risk.
If the investment does not yield the expected returns, it can lead to financial strain. However, successful CapEx investments can significantly boost productivity and profitability. OpEx, being more flexible and adjustable, generally involves lower risk.
Which is better: CapEx or OpEx?
The choice between CapEx and OpEx depends on a company’s strategic goals and financial situation. CapEx is better for investments that provide long-term value and competitive advantage.
Businesses with stable cash flows and a need for long-term assets benefit from CapEx, as it enables them to build and maintain infrastructure. This type of investment can support sustained growth and expansion.
Businesses with stable cash flows and a need for long-term assets benefit from CapEx, as it enables them to build and maintain infrastructure. This type of investment can support sustained growth and expansion.
Criteria | CapEx | OpEx |
Definition | Long-term expenditure with a future benefit, adding value beyond current tax year | Expense incurred due to ordinary company operations, less than 12 months |
Examples | Machinery, intellectual property, land, computers, equipment | Rent, salaries, insurance, utilities |
Also known as | Capital Expenditure, Capital Expense | Operating Expense, Operating Expenditure, Revenue Expenditure |
Accounting treatment | Tangible assets depreciated and intangible assets amortised with time | Fully deductible for the accounting period where they were incurred |
Payment | Upfront | Monthly or annual installments |
OpEx is preferable for maintaining operational flexibility and reducing upfront costs. In contrast, CapEx involves larger, long-term investments that provide value over time.
Companies in rapidly changing industries might opt for OpEx to stay agile and adaptable.
For instance, instead of purchasing expensive IT infrastructure, a company might use cloud services, which are classified as OpEx. This approach can help manage costs more effectively and adjust spending based on current needs. OpEx allows for more predictable budgeting.
Businesses with tighter budgets or those facing uncertain economic conditions often favour OpEx to avoid the significant upfront costs associated with CapEx, while companies with a long-term growth strategy may choose CapEx to build lasting value and capabilities.
Companies in rapidly changing industries might opt for OpEx to stay agile and adaptable.
For instance, instead of purchasing expensive IT infrastructure, a company might use cloud services, which are classified as OpEx. This approach can help manage costs more effectively and adjust spending based on current needs. OpEx allows for more predictable budgeting.
Businesses with tighter budgets or those facing uncertain economic conditions often favour OpEx to avoid the significant upfront costs associated with CapEx, while companies with a long-term growth strategy may choose CapEx to build lasting value and capabilities.
Recap of CapEx vs OpEx
Both CapEx and OpEx are foundational accounting and investing terms. Business executives need to decide whether or not to favour OpEx or CapEx when making decisions about financial allocations.
CapEx allocations can pay off, with time, as the business grows. However, OpEx is essential to daily operations and is preferential from an income tax perspective. As always, the correct approach depends on specific company goals as well as the broader industry segment.
CapEx allocations can pay off, with time, as the business grows. However, OpEx is essential to daily operations and is preferential from an income tax perspective. As always, the correct approach depends on specific company goals as well as the broader industry segment.
FAQ on CapEx vs OpEx
Q: Why is OpEx often considered better than CapEx?
OpEx is often seen as better than CapEx because it provides more flexibility. OpEx involves regular, ongoing costs that can be adjusted or reduced based on business needs, while CapEx involves significant upfront investments that tie up capital. OpEx can also offer tax benefits since these expenses are fully deductible in the year they are incurred, whereas CapEx must be depreciated over time.
Q: Is software CapEx or OpEx?
Software can be either CapEx or OpEx, depending on how it is acquired and used. If software is purchased outright or developed in-house, it is considered CapEx and is capitalised on the balance sheet, then depreciated over its useful life. However, if software is subscribed to as a service (SaaS), the costs are considered OpEx since they are ongoing operating expenses.
Q: Who pays OpEx?
OpEx is paid by the company’s operating budget. These expenses are covered by the revenue generated from the company's daily operations. All departments within a company typically contribute to OpEx, including salaries, utilities, rent, and other ongoing operational costs.
Q: Can you convert CapEx to OpEx?
Yes, CapEx can be converted to OpEx in some cases. This is often done through leasing or renting instead of purchasing assets outright. For example, instead of buying servers (CapEx), a company might choose to use cloud services (OpEx). This conversion helps manage cash flow more effectively by spreading costs over time rather than incurring a large upfront expense.
Q: Can CapEx be negative?
CapEx itself cannot be negative, as it represents spending on long-term assets. However, negative values might appear in financial statements due to asset disposals, sales, or returns of capitalised investments. When assets are sold or returned, the proceeds are recorded as negative CapEx, reflecting a reduction in capital expenditures.
- Cash flow: The net amount of money moving into and out of a business over a specific period.
- Intellectual property: Non-physical assets like patents, trademarks, or copyrights that can provide long-term competitive advantages.
- Useful life: The estimated period over which an asset remains productive or provides economic benefits to the business.
- Materiality threshold: A benchmark used to determine whether an expense is significant enough to be recorded as an asset or should be expensed immediately.
- Tax-deductible: An expense that can be subtracted from a company's taxable income, thereby reducing its overall tax liability.
