What is the CapEx formula? (Quick answers)
The capital expenditure formula is super simple:
CapEx = ΔPP&E + Depreciation
CapEx = capital expenditures
ΔPP&E = Change in PP&E (property, plant, and equipment), or:
ΔPP&E = Current period PP&E - the prior period PP&E.
Depreciation = any depreciation expense incurred over the period.
How to calculate capital expenditures ratio (CapEx ratio)
Here's the formula to calculate the CapEx ratio:
CapEx ratio = Operating cash ÷ CapEx
A CapEx ratio > 1.0 means you have sufficient funds to spend on capital expenses.
If your number is under 1.0? Consider financing to extend our purchasing power to fuel growth.
If you want to know more about calculating capital expenditures, keep reading.
What are capital expenditures (CapEx)?
Capital expenditures (CapEx) are funds a company spends to acquire, maintain, and upgrade fixed assets like property, buildings, or equipment (PP&E).
Capital expenditure purchases are most often used to fuel development and growth for the company. Examples include the construction of new facilities, maintenance, and expansion of existing facilities, and the purchase or upgrade of technology.
For example, new computers for a company's office are an item of capital expenditure. They're a considerable expense (often in the tens of thousands for just a few units) and the type of purchase that only occurs once every few years.
On the other hand, buying a few new office chairs wouldn’t be a capital expenditure. It’s a minor purchase that doesn’t affect long-term growth or produce an asset.
That said, a significant build-out of a new location might be considered CapEx since the project focuses on growing the business—and the office chairs could be rolled into that.
Another qualifying consideration is total cost.
Companies usually have a cap on expensing anything under $1,000. For instance, if something can be capitalized—if the total cost of that item is over $1,000—it will go on the balance sheet and then be expensed over the useful life.
So back to our office chairs—if you bought them in bulk and their cost surpassed your expensing threshold, they could be CapEx. But otherwise, you wouldn't capitalize them.
If that sounds a little arbitrary, it's because it is. What's important is maintaining consistency in how you decide what is and isn't CapEx.
How are a company's capital expenditures different from its operating expenses?
Operating expenses are the things a business needs to spend money on to function.
A capital expense is money spent on a fixed asset like machinery or a building.
So yes, while the company needs machinery or a physical location to function, they're still considered CapEx because they're fixed assets.
Capital expenditures are also subject to accumulated depreciation—the loss in value those assets sustain with age.
Types of capital expenditures
Not every large-ticket purchase is a capital expenditure (although many are). CapEx purchases are differentiated by their role in furthering the company’s goals and expansion efforts. They are often (but not exclusively) physical assets with long lifespans.
Common types of capital expenditures include:
- Land and buildings
- Vehicles and heavy equipment
- Computer hardware and software
- Intangible assets like patents, copyrights, and intellectual property (IP)
Some businesses treat certain upgrades and maintenance costs as capital expenses if they significantly increase the value or lifespan of an asset.
What are fixed assets?
Fixed assets are long-term tangible properties (like buildings) or equipment (like machinery) that a company owns and uses to make a profit.
Fixed assets are fixed because the company isn't expected to sell them (or use them to the point of exhaustion) within a year of their purchase. So they're fixed.
On the balance sheet, these are often recorded as PP&E (property, plant, and equipment).
How does a capital expenditure appear on the three financial statements?
Capital expenditures costs appear in different sections on a company’s cash flow statement, balance sheet, and income statement. The spending on purchases appears as a liability, while the resulting physical assets appear on the three financial statements as an asset.
In more detail, CapEx appears on each financial statement as follows:
- On the balance sheet, capital expenditures are recorded in the "property, plant and equipment (PPE) line item, which represents long-term assets such as buildings, vehicles or machinery. It is listed in the long-term section of the balance sheet and depreciates over time.
- The income statement reports capital expenditures under long-term investments or non-operating expenses. They are subtracted from total revenues to calculate net income for the period.
- On the cash flow statement, capital expenditures are reported under investing activities. They show up as an outflow from a company’s operating activities. They can measure how much money was spent to acquire new assets during the prior reporting period.
How does CapEx relate to cash flow?
Capital expenditures involve spending money to purchase assets with the expectation that these assets will increase the growth or prosperity of the company.
As explained previously, because CapEx is a non-cash expense, it does not directly affect cash flow, but the indirect effect is still important to consider as it can lead to a decrease in cash on the balance sheet.
When considering CapEx for accounting purposes, looking at the initial cost of purchasing an asset and any associated costs, such as taxes or interest, associated with taking out a loan is important. Additionally, it's important to consider depreciation and amortization when factoring in CapEx expenses into the overall cash flow.
By properly tracking capital expenses and their associated costs over time, companies ensure they make sound financial decisions when investing in assets.
How does depreciating an asset improve cash flow numbers?
While companies can’t automatically write off the cost of expenses to free up cash, reducing taxes through depreciation leaves more money in the bank for other purposes.
FP&A can report better cash flow numbers offset by tax reductions by recording regular depreciation intervals.
This gives companies more money to invest in operations and other income-generating activities instead of spending that money on taxes. Additionally, this helps control debt levels as the company can spread out payments over a long period of time.
How are capital expenditures used in calculating free cash flow-to-equity (FCFE)?
Capital expenditures are also used in calculating free cash flow to equity (FCFE). FCFE is the amount of cash available to equity shareholders.
The most common way to calculate FCFE is:
FCFE = EPS − (CapEx − Depreciation) × (1 − DR − ΔC × (1 − DR))
FCFE = Free cash flow-to-equity
EPS = Earnings per share
DR = Debt ratio
ΔC = ΔNet capital or change in net working capital
What considerations should I make for capital expenditures?
When making a capital expenditure it’s important to look at the expense in the larger context of your financial position.
Think about the total cost of the purchase (including taxes and interest payments), depreciation and amortization schedule, availability of funds for the purchase, and whether or not it aligns well with the company’s long-term goals.
Some factors to consider when you’re considering or budgeting for a capital purchase:
They’re a commitment
Capital expenditures are big-ticket items.
They often fulfill a specific need of your individual business. While they offer huge benefits to your growth potential, their value doesn’t always translate to other businesses.
For this reason, resale prices on many capital assets are much lower than your original investment. When considering a large capital investment, be sure there’s a long-term business case to support it.
They decline in value over time
While it’s true that capital expenditure purchases carry tax benefits, these are existing fixed assets that will lose value over time.
Your asset value will decline as you use these purchases within your business.
Again, be sure the investment is worth the long-term upside.
They may strain cash flow
Large capital asset purchases can be a big drain on your cash flow.
Ensure you have the necessary funds to cover the upfront cost of any major acquisition.
Also, build these purchases into your long-term budget so you don’t experience any surprises.
They aren’t always scalable
Capital expenditures should give you long-term value for the investment. That said, these purchases should be able to keep up with your businesses as you scale.
All these factors should be carefully weighed to ensure an organization effectively uses its capital expenditure budget.
Look at the long-term prospects of your purchase. Will a piece of equipment you purchase this year be able to keep up with production demands a few years later? If not, consider your future ability to recover value on the purchase.
What impact do capital expenditures have on taxes?
When it comes to expenses, companies must be careful how they present expenses on the books and pay taxes on those assets.
First, how does depreciation work?
Depreciation is an accounting technique that spreads the capital expenditure cost over its expected useful life.
In basic terms, it’s a way for businesses and organizations to account for the wear and tear on their equipment and property over time and decrease their taxable income by recognizing a portion of the cost of a specific asset as an expense each year.
For example, if a business owner purchased a new company vehicle for $50,000, depreciation would help them spread out the tax impact of the purchase.
Assume the truck has an expected useful life of 10 years. In normal depreciation, the company could depreciate the purchase at $5,000 annually over those 10 years.
This means that each year, the company could use the $5,000 depreciation as an expense on their taxes and reduce their taxable income by that amount.
This helps companies spread out the cost of large expenditures over a long period and avoid taking on too much debt when making these purchases.
Conclusion: Make your capital expenditures planning faster and easier
Now you know all about the CapEx formula.
You know how to calculate capital expenditures, locate and read off the correct items from the income statement and balance sheet, and even calculate the CapEx ratio.
Want to track your CapEx activity in Excel? Cube makes it easy with the first Excel-native FP&A platform. Check out our free Capital Expenditures template to get started.
Now you know what you need to know about CapEx!