Capital expenditure, or capex, is hugely important to business growth and long-term success. Whether acquiring new machinery, upgrading infrastructure, or investing in technology, capex represents a company’s commitment to its future. But how does it differ from other types of spending, and why is it so important?
In this article, we will answer the question ‘what is capex?’, exploring its different types and how to track and calculate it!
What is capital expenditure (capex)?
Capital expenditure, or capex, is the money a company spends to purchase, maintain or improve fixed assets for their business. These assets can include buildings, machinery and technology. Unlike day-to-day operational expenses, capital expenditures are long-term investments designed to improve a company’s efficiency or capabilities over several years.
For example, a manufacturing company might invest in a new production line to increase output, while a tech firm could build a data centre to support its growing digital infrastructure. These expenditures are important to drive growth and make sure the business is competitive in its industry.
What are the different types of capital expenditure?
There are two main types of capital expenditure, and understanding the differences between these two types of capex will help businesses allocate resources effectively between sustaining current operations and pursuing growth opportunities.
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- Expansionary capex: Expansionary capital expenditures are investments made by a business to grow operations, such as a retail chain opening new stores in untapped locations or a manufacturing company buying extra machinery to improve its output.
- Maintenance capex: Maintenance capital expenditure is spending with the aim of replacing, repairing or maintaining existing assets to make sure operations run smoothly. Examples of maintenance capex include renovating an office building to meet safety standards or replacing old or broken equipment in a factory to prevent downtime.
Why is capital expenditure important?
Capital expenditure is hugely important for businesses that want to expand, innovate and stay ahead of their competitors. By investing in long-term assets, businesses can expand operations, improve efficiency, and adapt to changing market conditions. Let’s explore the benefits of capital expenditure in more detail.
Growth and innovation
Capex allows companies to scale their capabilities, either by increasing production capacity, enhancing technology, or entering new markets. These investments are often the foundations for success in the future, enabling businesses to develop new products, improve operational efficiency, and deliver better customer experiences.
Finance
On a company’s balance sheet, capital expenditures are treated as assets rather than immediate expenses, to reflect their long-term value. Although these expenditures have significant upfront costs, their cost is spread out over several years through depreciation or amortisation. This spreading of cost makes capital expenditures an important part of a company’s financial strategy.
Sustainability
Capex also plays an essential role in sustainability, by ensuring that businesses maintain operational efficiency and are able to meet future demands. Regular investment in maintaining or upgrading assets prevents disruptions, reduces long-term costs, and helps to ensure that the organisation remains resilient.
How is capital expenditure funded?
Capital expenditure can require significant upfront costs, and businesses use various methods to secure the necessary funding. Let’s take a look at some of the funding methods that organisations use to purchase capex assets:
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- Retained earnings: Profits from previous years can be reinvested into the business to fund Capex without taking on debt.
- Loans or bonds: Companies may borrow money from banks or loan companies or issue bonds to investors to raise the capital needed for large expenditures.
- Equity financing: Businesses can raise funds by selling shares to investors, providing access to significant capital in exchange for partial ownership.
Investing in capital expenditure often comes with capital allowance tax benefits. Assets purchased through capex are typically depreciated over their useful life, allowing businesses to deduct a portion of their cost annually. This depreciation reduces taxable income, providing financial relief over time.
How is capex calculated and tracked?
Tracking and calculating capital expenditure is essential for effective financial management. By understanding how much is being spent and where businesses can ensure their investments are aligned with strategic goals.
How to calculate capital expenditure
Capex is calculated using the formula:
Capex = change in fixed assets + depreciation expense
This formula captures both the increase in a company’s fixed assets and the cost of wear and tear accounted for through depreciation.
How to budget for capital expenditure
Planning capital expenditure involves creating long-term budgets that account for both immediate needs and growth strategies. Businesses tend to prioritise projects based on their expected ROI, ensuring that resources are allocated to areas that will achieve the best results.
How to track capital expenditure
Tracking capex effectively helps make sure finances are staying on track. Businesses tend to use tools such as enterprise resource planning (ERP) systems, financial management software, and capex-specific tracking platforms. These tools provide real-time visibility into spending, help maintain budgets, and allow for better forecasting.
By combining accurate calculations, strategic planning, and modern tracking tools, businesses can manage their capital expenditure more effectively, ensuring that every investment contributes to growth, efficiency, and stability.
What’s the difference between capex and opex?
Understanding the difference between capital expenditure (capex) and operating expenditure (opex) is essential for effective financial planning. While both are crucial for running a business, they serve distinct purposes and are accounted for differently. Let’s explore the definitions of each so you can understand the differences between the two.
As we’ve discussed, capex is a long-term investment in fixed assets such as buildings, machinery and technology, intended to generate value over an extended period. Opex, meaning operational expenses, are the day-to-day expenses that are required to keep the business running. These expenses include bills, office supplies and salaries.
While capital expenditures are recorded as assets and depreciate over time, operational expenditures are fully expensed in the year they occurred, and they are deducted entirely from taxable income in the year incurred.
Whether companies prioritise capex or opex depends on their goals for the year. For example, organisations often prioritise capex when their aim is to expand their business or improve their operational efficiency. For instance, a business might invest in new technology to streamline production or open a new location to increase market reach.
On the other hand, opex will take precedence when companies focus on maintaining daily operations or controlling short-term costs. For example, businesses may lease equipment instead of purchasing it outright to reduce immediate outgoings or avoid long-term commitments.
How Eureka Capital Allowances can help
Capital expenditure is essential to help companies grow. By investing in assets that generate value over the long term, businesses position themselves to stay competitive and meet evolving market demands. However, making the right Capex decisions requires careful strategic planning and thorough financial analysis to ensure these investments align with broader business objectives.
At Eureka, we have a team of Capital Allowances Consultants with over 20 years’ of experience, helping business property owners unlock thousands of pounds of hidden tax relief in their property. Contact us today to discover how we can help you.
