What is Capital Expenditure?
It is an expenditure that is immediately capitalized (i.e., not expensed directly through the income statement) but instead is seen as an investment into the company’s ongoing operations.
Capex is vital for companies to grow and maintain their business. A company’s capital expenditures do not initially appear on the earnings report but can have a big impact on cash flow. Examples of capex are shown below:
- Office buildings
- Equipment and machinery
Capital expenditure can be derived from a company’s cash flow statement, reported in the cash flow from investing activities. It can also be calculated using a BASE calculation for net PP&E and rearranging for capex.
BASE analysis compares the beginning amount of net PP&E in the balance sheet (prior year) plus or minus changes during the current period, in order to give the ending amount of net PP&E in the balance sheet (current year). The net PP&E BASE is as follows:
The current PP&E is the PP&E reported in the previous accounting period with the addition of capital expenditure and subtraction of depreciation. The formula can be rearranged to give the capex formula shown below:
Capex = PP&E (Ending) – PP&E (Beginning) + Depreciation (Subtraction)
PP&E stands for property, plant, and equipment and represents the fixed, tangible assets owned by a company. They are physical assets that a company cannot easily liquidate.
- Locate depreciation on the income statement (often not shown and can be embedded in COGs and SG&A or PP&E note).
- Locate the current period property, plant & equipment (PP&E) on the balance sheet.
- Locate the prior period PP&E on the same balance sheet.
- Rearrange BASE to arrive at capex.
Example of Capex Calculation
Company A has the following information from its financial statements:
|Net amount of PP&E in current year||
|Net amount of PP&E in prior year||
Based on the above information, the capital expenditures made by Company A during the period can be calculated as:
|PP&E (Current Period)||
The company has invested 200.0 into its property, plant and equipment. The company has capitalized the expense on their balance sheet resulting in an increase in the net book (and gross) value of PP&E. Depreciation is a cost allocation system and represents the consumption of benefits over time, matching the revenues in any period with the PP&E cost of producing those revenues.
To Capitalize or Expense
A business purchases assets with the expectation it will generate future economic benefits. An asset with the expectation of producing benefits in less than 12 months (current assets) is expensed through the income statement for the current accounting period.
A tangible long-term asset expects to produce future economic benefits for more than 12 months. Rather than expense the cost of the asset in one accounting period, a business will capitalize the cost of the asset over its useful life. This results in the future benefits generated by the asset being matched with the cost across future accounting periods.
Reporting assets this way means the business won’t incur a large one-off expense in its income statement, but instead will spread the cost of the asset across multiple accounting periods.