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In order to earn money, businesses first have to spend it—and capital expenditures (CapEx) represent the biggest up-front investments your company will make.
These include fixed assets that require a substantial financial investment (such as property, equipment or technology), but contribute to the long-term growth, improvement and expansion of your business.
But that only happens when CapEx decisions are backed by smart financial insights and the right level of due diligence. With capital expenditures, there’s always the risk your company could be left with a large expense for an asset that’s not yielding value.
For this reason, it’s essential to have a solid plan in place to guide CapEx decisions, especially in capital-intensive industries like manufacturing.
When you do, you can leverage capital expenditures to further your business objectives, drive innovation, elevate customer experience and gain a competitive advantage in your market.
In this article, we’ll walk through everything your finance team needs to know about CapEx and how to budget and plan around it effectively.
Capital expenditures are spend related to buying and improving your company’s long-term assets. They typically encompass purchases that fall under the property, plant and equipment (PP&E) category, including things like:
These assets are expected to start generating revenue over an extended period of time—usually more than one accounting year. As such, the financial purpose of CapEx assets is to enhance a company’s productive capacity or efficiency to yield future economic benefits.
Fo Consider a snow plowing company that purchases newer trucks to replace its old fleet. The new trucks cost $500,000 total to purchase up front. This expense is recorded as a capital expenditure as the new trucks are expected to deliver financial benefits over a number of years. These benefits include:
Over the lifetime of the new trucks, their financial value will far surpass the initial $500K investment in both the form of cost savings and new business generated.
Decisions around capital expenses like the one in this example should be made based on strategic considerations such as:
FP&A departments, of course, plays a central role in this process, with the evaluation of key metrics such as expected returns, potential cost savings, revenue performance and larger market trends.
Effectively weighing all these factors is critical, as it determines whether a capital expense will drive your organization forward or serve as a proverbial financial anchor holding it back from its full profit potential.
If you're looking for an easy way to calculate capital expenditure, you can download our CapEx template for Excel.
One key distinction that’s critical to understand is the one between CapEx and OpEx, another related but separate part of your annual budget.
Operating expenditures (OpEx) refer to a company’s day-to-day operating expenses, or the tasks and activities essential for remaining in business. On financial statements they include things like:
While CapEx expenses are spread over the lifetime of an asset, OpEx expenses are treated as immediate expenses deducted from revenue in the same accounting period.
Capital expenses are spent in large quantities and are not easily reversible, while operational expenses are spent in smaller increments and can often be reversed if needed. CapEx costs are not fully tax deductible in any single year, while OpEx costs are (expensed on your balance sheet).
The chart below shows an overview of the key differences between CapEx and OpEx:
It’s important to note that there are some costs related to CapEx assets that may fall into your OpEx budget. These may include general upkeep and small repairs, employee training, insurance costs or utilities associated with ongoing use of an asset.
Effective OpEx management also impacts your ability to invest in capital expenditures because when operational costs are optimized and well-managed, you have more working capital to invest in long-term assets for your business.
CapEx should be recorded in the investing activities portion of your cash flow statement.
Below are the steps you’ll take to calculate your capital expenditures and in turn, assess how they fall in line with the rest of your budget and strategy.
Start by identifying CapEx purchases you made during the month, quarter, year (or whichever time period you’re measuring).
This should include transactions for purchasing or upgrading new equipment, renovating facilities, significantly upgrading technology hardware or systems or any other significant investments made to drive long-term business operations and growth.
Your CapEx calculations should also include costs related to acquiring and implementing a new asset or improving existing ones—in other words, costs that may not be included in the initial purchase price. This usually includes installation or transportation fees and similar expenses directly attributable to the asset.
Be sure to exclude any expenses that are not considered capital in nature. This generally includes routine maintenance costs, repairs or any expenses related to day-to-day operations (remember, these should fall under OpEx instead). CapEx specifically focuses on investments that have a long-term impact on your company's operations and profitability.
Add up the cost of all the relevant assets identified in the first and second steps. This will give you the total CapEx for the reporting period. Over time, you can track your balances across reporting periods to get an idea of your CapEx spending trends.
To verify your CapEx calculations, cross-reference them with the company's financial statements. Look for all financial reporting specific line items related to CapEx and ensure you’ve accounted for everything that should be included.
Depreciation is the gradual decrease in value of an asset over its useful life (i.e. the length of time it remains usable and valuable to your business), and reflects inevitable wear and tear, obsolescence, and/or loss of value of an asset.
Depreciation must be accounted for in order to calculate CapEx, and it’s most commonly done using the straight line method.
With this method, you’ll start by estimating two key numbers: estimated useful life (the number of years you expect the asset to generate economic benefits for your company) and salvage value (the value you could earn from selling or disposing of the item when it’s no longer used).
Next, subtract the salvage value from the cost of the asset to find the amount that needs to be depreciated over the lifetime of the asset. Then, divide that number by the useful life to find the amount of depreciation to be recognized for that asset in each accounting year.
Once you’ve completed the steps above, you can perform your CapEx calculation. Take your net increase in capital expenses (capital expenses for the current accounting period compared to the previous period), then add depreciation costs for the current period.
Here’s what the formula looks like:
If you don't want to use the CapEX formula, then try our calculator tool below.
CapEx decisions should always be backed by an intentional strategy, smart planning and collaboration between the right stakeholders.
Let’s walk through some of best practices for effective CapEx management, so you can maximize the value your business gains from capital expenses over time.
Closely align your CapEx decisions with your company's strategic goals and objectives. For example, these might be scaling up your services or modernizing your technology infrastructure. Be sure your investments in capital assets support your company's growth plans, market positioning and competitive strategy.
Facilitate transparent communication between all department leaders involved in the CapEx budgeting process (corporate budgeting software that focuses on making it easier for your finance team to collaborate with and receive inputs from budget contributors can be especially helpful here).
Because the nature of CapEx purchases makes them nearly impossible to reverse, it’s important to put sufficient controls in place to ensure you don’t exceed your targets.
This requires due diligence in advance of purchases and threshold controls during the budgeting process. Know the market price of CapEx assets you plan to purchase as well as the maximum you can and/or are willing to spend.
Corporate budgeting software can help you do this more efficiently and comprehensively by enabling you to set up controls, thresholds, and specific approval workflows to ensure you don’t spend more than what’s planned.
Robust financial analysis capabilities—both from your teams and your technologies—are crucial for understanding the feasibility, expected value, and ongoing progress of CapEx projects.
Before moving forward with new asset requests, your finance team should evaluate historical and current financial data and use financial forecasting and scenario analysis techniques to see if now is the best time to be making this large investment.
Identifying and assessing risks associated with taking on new—or upgrading existing—capital assets is vital to mitigate potential setbacks. Risks may include technological obsolescence, regulatory changes, market shifts, cost overruns or delays.
CapEx purchases inherently come with some level of risk— it can’t ever be totally avoided. But by performing the right levels of due diligence, financial analysis, and ongoing performance assessment, your teams can reduce risk, quickly address issues that arise, and make smart decisions to maximize the ROI from your capital expenditures.
Because capital expenditures are significant investments, naturally, they require buy-in (and usually formal approval) from high-level leaders and stakeholders, including managers, investors, and C-suite executives. It’s important to define the strategic thought process behind a CapEx decision when you’re proposing it to company leaders—and provide concrete numbers too.
Documenting the business case for CapEx investments and communicating it to everyone impacted by the purchase goes a long way in gaining stakeholder buy-in. The actual communication is executed by the relevant business department, but finance teams can provide them with compelling financial data to support their case.
CapEx investments need continual performance monitoring and management in order to be successful. This means controlling costs, optimizing implementation processes and effectively managing resources. That’s where collaboration between business teams responsible for the asset and finance teams capable of tracking its financial performance is particularly essential.
A formalized evaluation and review of your CapEx projects is also crucial for tracking performance against key objectives, identifying deviations, and making necessary adjustments. This enables more informed decision-making and quicker course correction to maximize returns from your capital expenses.
Depending on the type of CapEx investment you’re making, you may need to consider legal regulations and compliance standards. Some common examples include obtaining the right permits for a new building or adhering to data privacy regulations when using a new technology tool.
Without performing legal and compliance due diligence before making CapEx investments, you may be stuck with unexpected limitations on how you can use new assets and/or fines related to unintentional misuse or mishandling.
These considerations are relevant to finance teams because they often come with added costs that must be included in CapEx calculations on financial statements.
Establishing a culture of continuous improvement within your CapEx planning—and financial planning overall—allows you to learn from past experiences and optimize future investment decisions for your business.
After you make a significant CapEx investment and as you track returns on previous ones, set aside time for discussion around what the team has learned and how you can improve CapEx decision-making processes and/or investment strategies for the future.
Capital expenditures play a pivotal role in a company’s ability to grow and be profitable long-term, but it must be managed effectively in order to yield value.
Finance teams need to effectively partner with key decision makers and stakeholders across the business to align CapEx spending with strategic goals and track ongoing costs and returns.
The best way to ensure you’re planning for capital expenses effectively, is to make sure your finance team has complete visibility into your costs, asset depreciation and amortization and working capital needs. A complete planning software that can unite all this data for you in one central database—integrating with your financial systems and automatically updating your reports with the latest actuals—can make this much easier.
Did you find this article helpful? If so, you might be interested in this related content:
5 Ways to More Effectively Prioritize Capital Expenditure Planning
Streamlining Your CapEx Budgeting Process: A How-To Guide
4 Tips for Long-Range Planning During Turbulent Times
Manage all of your new and existing assets with this free Capital Expense Budget Template.
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