Capital expenditure is money a company uses to acquire new assets, add to current assets, or improve assets for the benefit of improving a business, such as buying new equipment. Capital expenditures are “capitalized” as an asset on the balance sheet and depreciate over time, rather than showing as an expense on the income statement.
Let’s review a detailed description of capital expenditure with examples and comparisons, and examine what a company’s capital expenditures can tell investors.
Definition and Example of Capital Expenditure
Capital expenditure, also known as CapEx, is money a business spends to acquire, improve, or maintain physical long-term assets. Capital expenditures are used to develop a new business or as a long-term investment of an existing business.
Capital expenditures are necessary for a company to grow its current business operations. They are the part of the budget allocated to maintaining and improving the equipment and assets to keep the business running. They can also be expenses related to the expansion of the company by acquiring new assets.
- Alternative name: Capital expenses, CapEx
For example, a plastic manufacturing plant may purchase property and infrastructure to expand its business capacity. All the expenses related to buying the property, buildings, equipment, and machinery would be capital expenditures.
Costs associated with improving a machinery’s useful life would also be considered a capital expenditure because they help extend the useful life of the equipment.
How Capital Expenditures Work
Rather than being shown as an expense, capital expenditure is recorded or capitalized as a long-term asset. It is considered an investment because the company is expanding or maintaining its business and assets.
Examples of common capital expenditures are purchasing long-term assets such as equipment, property, tools, infrastructure, machinery, warehouses, furniture, and vehicles; or intangible assets like patents and licenses.
However, expenses related to the repair and general maintenance of an asset are not considered a capital expenditure. Instead, they’re classified as “repairs.”
Types of Capital Expenditure
The IRS categorizes types of capital expenses that businesses can capitalize: business startup costs, business assets, and improvements. These specific expenses may include:
- Intangible assets (patents, licenses, trademarks, etc.)
In short, any expenditures related to acquiring new assets such as those listed above or upgrading these assets is a type of capital expenditure.
Capital Expenditure vs. Operational Expenditure
Capital expenditures are related to growing and improving the assets of a business. They are considered long-term investments. Operational expenditures (OpEx), on the other hand, are expenditures related to the day-to-day operation of a business.
Here’s how they compare:
|Capital Expenditure (CapEx)||Operational Expenditure (OpEx)|
|Long-term investments in improving and acquiring new assets for a business||Shorter-term expenses related to the day-to-day operations of a business|
|Items are capitalized as an asset||Items are expensed|
|Assets that depreciate over time||Expenses that are accounted for in the current year’s accounting period|
|Examples include improving or buying assets such as property, a plant, and equipment (PP&E)||Examples include expenses such as rent, utilities, advertising, administration fees, etc.|
What It Means for Individual Investors
For investors to better understand the financial health and prospects of a business, they should thoroughly understand the capital expenditures.
A company that has a sound strategy for how they manage its capital expenditures can provide a potential investment opportunity. Of course, investors should consider many other aspects of a company before investing.
After all, a company that takes its profits and reinvests them into promising, long-term assets may have a well-developed plan for long-term growth. Conversely, a company that does not focus well on investing in its growth may be headed for challenges.
- Capital expenditures are money a company uses to improve or acquire new assets with the objective of growing and improving the business as a whole.
- Capital expenditures are often referred to as CapEx or capital expenses.
- Examples of capital expenditures include improving or purchasing assets such as property and equipment.
- Operational expenditures are short-term, day-to-day expenses, whereas capital expenditures are long-term investments in acquiring and improving assets.
- A business with a proven track record of a sound capital expenditure strategy may be a potential investment opportunity, with other financial factors considered.