2/14/2020 Capital Expenditure – CapEx Definition

Capital Expenditure – CapEx Definition

By WILL KENTON Updated Jun 25, 2019

What Are Capital Expenditures – CapEx?

Capital expenditures, commonly known as CapEx, are funds used by a company to
acquire, upgrade, and maintain physical assets such as property, buildings, an
industrial plant, technology, or equipment.

CapEx is often used to undertake new projects or investments by the firm. Making
capital expenditures on fixed assets can include everything from repairing a roof to
building, to purchasing a piece of equipment, to building a brand new factory. This
type of financial outlay is also made by companies to maintain or increase the
scope of their operations.

Put differently, CapEx is any type of expense that a company capitalizes, or shows
on its balance sheet as an investment, rather than on its income statement as an
expenditure.

The Formula for CapEx Is

CapEx = ΔPP&E + Current Depreciation
where:
CapEx = Capital expenditures
ΔPP&E = Change in property, plant, and equipment

How to Calculate CapEx

If you have access to a company's cash flow statement, no calculation is needed.
Look for the company's capital expenditures in the Cash Flows From Investing
section of the company's cash flow statement.

You can also calculate capital expenditures by using data from a company's income
statement and balance sheet. On the income statement, find the amount of
depreciation expense recorded for the current period. On the balance sheet, locate
the current period's property, plant, and equipment (PP&E) line-item balance.

Locate the company's prior-period PP&E balance, and take the difference between
the two to find the change in the company's PP&E balance. Add the change in
PP&E to the current-period depreciation expense to arrive at the company's
current-period CapEx spending.

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What Does the CapEx Metric Tell You?

Capital expenditure should not be confused with operating
expenses(OpEx). Operating expenses are shorter-term expenses required to meet
the ongoing operational costs of running a business. Unlike capital expenditures,
operating expenses can be fully deducted on the company's taxes in the same year
in which the expenses occur.

CapEx can tell you how much a company is investing in existing and new fixed
assets to maintain or grow the business. In terms of accounting, an expense is
considered to be a capital expenditure when the asset is a newly purchased capital
asset or an investment that has a life of more than one year, or which improves the
useful life of an existing capital asset. Expenses for items such as equipment that
have a useful life of less than one year, according to IRS guidelines, must be
expensed on the income statement.

If an expense is a capital expenditure, it needs to be capitalized. This requires the

company to spread the cost of the expenditure (the fixed cost) over the useful life of
the asset. If, however, the expense is one that maintains the asset at its current
condition, the cost is typically deducted fully in the year the expense is incurred.

CapEx can be found in the cash flow from investing activities in a company's cash
flow statement. Different companies highlight CapEx in a number of ways, and an
analyst or investor may see it listed as capital spending, purchases of property,
plant, and equipment (PP&E), acquisition expense, etc. The amount of capital
expenditures a company is likely to have depends on the industry it occupies.

Some of the most capital intensive industries have the highest levels of capital
expenditures including oil exploration and production, telecommunication,
manufacturing, and utility industries. For example, Ford Motor Company, for the
fiscal year ended 2016, had $7.46 billion in capital expenditures, compared to
Medtronic which purchased PPE worth $1.25 billion for the same fiscal year.

KEY TAKEAWAYS
A capital expenditure is a payment for goods or services recorded, or
capitalized, on the balance sheet instead of expensed on the income
statement.
CapEx spending is important for companies to maintain existing property,
plant & equipment, and invest in new technology and other assets for
growth.
If an item has a useful life of less than one year, it must be expensed on the
income statement rather than capitalized.

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Example of How to Use Capital Expenditures

Aside from analyzing a company's investment in its fixed assets, the CapEx metric
is used in several ratios for company analysis. The cash-flow-to-capital-expenditure
ratio, or CF/CapEX ratio, relates to a company's ability to acquire long term assets
using free cash flow. The cash-flow-to-capital-expenditures ratio will often fluctuate
as businesses go through cycles of large and small capital expenditures.

A ratio greater than 1 could mean that the company's operations are generating
the cash needed to fund its asset acquisitions. On the other hand, a low ratio may
indicate that the company is having issues with cash inflows and, hence, its
purchase of capital assets. A company with a ratio of less than one may need to
borrow money to fund its purchase of capital assets.

CF to CapEx is calculated as follows:

Cash Flow from Operations

CF/CapEx =
CapEx
where:
CF/CapEx = Cash flow to capital expenditure ratio

Using this formula, Ford Motor Company's CF/CapEx is as follows:

$14.51 Billion
= 1.94
$7.46 Billion

Medtronic's CF/CapEx is as follows:

$6.88 Billion
= 5.49
$1.25 Billion

It is important to note that this is an industry specific ratio and should only be
compared to a ratio derived from another company that has similar CapEx
requirements.

Capital expenditure can also be used in calculating free cash flow to equity (FCFE)
to a firm with the following formula:

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FCFE = EP − (CE − D) × (1 − DR) − ΔC × (1 − DR)

where:
FCFE = Free cash flow to equity
EP = Earnings per share
CE = CapEx
D = Depreciation
DR = Debt ratio
ΔC = ΔNet capital, change in net working capital

Or, alternatively, it can be calculated as:

FCFE = NI − NCE − ΔC + ND − DR
where:
NI = Net income
NCE = Net CapEx
ND = New debt
DR = Debt repayment

The greater the capital expenditure for a firm, the lower the free cash flow to equity.

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