Capital Expenditure “CAPEX” – What Is, Types, Formula, And Importance

Capital expenditures, or better known as CAPEX, whose translation means a capital expenditure, are exactly those expenses that a company produces in capital goods that will generate interest for them and can be applied by purchasing new fixed assets or by increasing the value of already existing fixed assets.

In other words, CAPEX acts as a fund the company uses to keep its goods in the best production conditions to achieve stable operation, which also allows them to maintain the company’s own business. As a clear example of Capex, you have to buy new computers, new delivery trucks, or new factories.

Capital Expenditure “CAPEX” Types

The investment or the expense that the company can make in new goods can be classified into two types, in terms of the end of that investment:

  • Capex Maintenance: This type of Capex is known as the replacement investment. In other words, this type of investment is the one used to replace or cover deterioration and wear on equipment. That is, it could be understood as the necessary investment by the company to maintain the same level of production or current sales.
  • Capex expansion: This type of expense by the company is used to increase the current level of production or sales. In other words, it is the investment that is made to acquire new fixed assets, improve one’s own or both.

This means that the total investment or expense in Capex by a company will be the sum of the two types explained above. If these types of strategies are applied, the expansion will be reflected when the total level of Capex is greater than the payment expense. That is, this is not only investing in the replacement of assets but also to increase their quantity or to improve them.

Find Capital Expenditure “CAPEX” in the financial statements

This type of investment has a high impact on the finances of the companies that apply Capex, so it is easy to detect it directly in the statement of cash flows, more specifically it is reflected in the cash flow of the investment activities. On the other hand, there is another way to easily calculate the investment, and it is through the income statement and balance sheet.

Formula to Calculate Capital Expenditure “CAPEX”

As explained above, there is an extremely simple formula for calculating Capex. Mathematically, its calculation is as follows:

Capex = Fixed Assets Net Material (year t) – Fixed Assets Net Material (year t-1) + Current Depreciation (year t)

In other words, the following steps are followed to calculate the Capex:

  • The company’s balance sheet is used in the current year and the Net Assets data is located.
  • The Net Fixed Assets are subtracted from the Net Fixed Assets from the balance of the previous year.
  • The result obtained is added to the expense in depreciation of this year that is in the income statement.

Importance of Capital Expenditure “CAPEX”

The Capex is an indicator of great importance in companies, since, through this type of investment, the life cycle in which an organization is at a given time is determined.

In accounting terms, the exact expenses to face all the investments made are capitalized if it is possible to increase the useful value of the asset, and it is the duty of the company to distribute that capitalized expense evenly throughout its useful life. If the case is that the expense was made solely to keep the asset in optimal conditions, the expense cannot be capitalized and will become a deductible expense.

At the beginning of a company, it is common to note that the Capex will always be high since it takes the purchase of a series of capital goods to begin to develop the commercial activity of the company.

In cases where a company manages to develop faster than usual, the Capex will have levels higher than the depreciation of the fixed asset, this means that the value of the goods grows rapidly. On the other hand, if Capex is equal to or less than fixed asset depreciation, it is clear evidence that the company or organization is being decapitalized and a significant decline will occur.

Advantages and Disadvantages of Capex

1# Advantages of Capex

The main advantages that can be seen from Capex are considered as the following:

  • Acquired capital goods are understood as an investment.
  • Increase the cash flow of assets.
  • They will generate a long-term return.
  • You get more predictability.

2# Disadvantages of Capex

The main disadvantages that can be seen from Capex are considered as the following:

  • Depreciation of acquired assets will be noted.
  • It will be difficult to approve expenses.
  • High costs will be presented in the short term.

Capital Expenditure “CAPEX” problems

Although Capex offers a series of extraordinary advantages, it also has different negative variables, such as those presented below. This method does not take into account the periods of temporary capitalization or decapitalization of a company. On the other hand, it should be taken into account that there are different industries in which some will have higher access to capital than others, such as oil or telecommunications, so they will have a higher Capex level.

Unlike those industries, such as service companies, which are not as extensive capital, and that will present a lower level of Capex, but does not mean that they are not

This means that, although Capex is a very useful indicator, it should be used with caution, it is suggested to analyze it in conjunction with other indicators, since it can lead to the belief that the company is in a growth process when it is really at another time of the life cycle.

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Ahmed Ismail

I'm a Civil Engineer. I like reading everything related to Business so I decided to launch the "Fast Grow Company" website to help Entrepreneurs in their business journey. Keep updated and follow us.

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