Capital expenditure, often called CapEx, refers to funds that a business spends to acquire, maintain, or improve long-term assets. This form of company spending is considered an investment which adds economic benefit to operations through increased efficiency or capacity. Long-term assets are usually fixed and non-consumable. These assets can be tangible, such as machinery, land, buildings, equipment, vehicles, and software, or intangible, such as licenses or patents.
Capital spending enables a company to maintain its property and to invest in future growth. Unlike most other spending which is expensed on the income statement, capital spending is capitalized and shown on the balance sheet as an asset. The capitalized cost is offset over the useful life of the asset through periodic depreciation expenses.
Operating Expenses vs Capital Expenditure
Operating expenses (OpEx) are short-term expenses required for normal business operations. Operating expenses include rent, payroll, maintenance, utilities, materials, and supplies. These expenses are fully deductible from income in the year in which they are incurred.
Capital spending is money spent to acquire a new long-term asset or improve the life of an existing long-term asset. Any asset with a useful life of less than one year is not considered long-term and must be completely expensed in the year of purchase. If work on an asset merely maintains an asset's current condition without adding to its useful life, the cost would be similarly expensed.
Because of the very different accounting implications of CapEx and OpEx, many companies are shifting toward Software-as-a-Service (SaaS) models. SaaS models offer companies subscriptions to cloud-hosted software. By paying subscription fees instead of purchasing expensive software outright, businesses can free up available cash and better manage their operating budget. Avoiding software purchases can also minimize hardware and IT personnel outlays, channeling funds to other areas in order to boost financial performance.
Example: Categorizing Expenses
Walk-In Wellness is an urgent care center providing alternate medical care to emergency room services. Let's look at some of their spending and classify it accordingly.
- Purchase of bandages and over the counter medications: operating expense
- Purchase of x-ray machine: capital expenditure
- Repair potholes and paint parking lines in parking lot: operating expense
- Pave additional empty lot next door to create additional parking spaces: capital expenditure
How do I Account for Capital Expenditure?
The Internal Revenue Service (IRS) requires businesses to capitalize the cost of acquiring or improving tangible property. The cost of the property or improvement is shown on the company balance sheet as an asset under Property, Plant, & Equipment, and the expense is taken gradually through depreciation over the useful years of the asset's life.
The total amount of a company's capital spending during a year is most easily seen on the cash flow statement under investment activities.
Are Capital Expenditures Tax Deductible?
Capital expenditure is not directly and immediately tax deductible. However, the cost of the capital spend is divided over the asset's useful life, and that yearly depreciation amount is tax deductible each year. Instead of traditional depreciation, companies may also take advantage of bonus depreciation and Section 179, two IRS vehicles which accelerate depreciation for qualifying capital expenditures and offer substantial and immediate tax relief in the year of purchase.
Capital expenditure is an important marker of a company's financial growth. Although these expenditures are capitalized on the balance sheet and not shown on an income statement, analysts do pay close attention to capital spending as it directly impacts cash flow, growth, and performance.