The CapEx vs OpeEx Debate – Why and How does It Matter to Your Business?

Importance of Capital Expenditure

The decision on how much to invest in capital expenses is a vital decision made by an organization. They are important for the following reasons-

1. Long-term effect

The effect of capital expenditure decisions extends into the future. The scope of current production or manufacturing activities is mainly a result of capital expenditures incurred in the past. Current decisions on capital expenditures will influence the future activities of the company. CapEx is a major driver of the direction in which the organization is headed. Long-term strategic goals and the budgeting process of a company need to be in place before authorization of capital expenditure. 

2. Irreversibility

Capital expenses are often difficult to reverse, without the company incurring losses. The capital equipment purchased is usually customized to meet specific company requirements and needs. The purchased equipment is subject to depreciation and the market for used capital equipment is generally very poor. The expenses incurred due to the purchase of capital equipment are irreversible. 

3. High Initial Investment

Capital expenses are typically very expensive, especially for companies in the manufacturing, telecom, utilities, and oil industries. Capital investments in physical assets like equipment, buildings, or property offer the potential to provide long-term benefits but also involve huge initial investments. 

4. Depreciation

Although capital expenditures result in an increase in the asset accounts of the organization, they also lead to depreciation costs. Once capital assets start being put in service, depreciation begins, and the assets decrease in value throughout their useful lives.

Budgeting Capital Expenditure Effectively

Capital projects that involve large amounts of money need to be handled with caution, as they have a deep impact on the financial health of the organization. Effective planning and budgeting of capital expenditures ensures that CapEx remains under control. Here are some best practices in CapEx planning and budgeting –

Organize before you start

Capital expenditure budgeting requires detailed preparation before commencement, to ensure that they don’t go over budget. Before a project is begun, the scope of the project, realistic deadlines, and project plan need to be reviewed and approved. At the planning stage, you must think about how many internal resources are needed, like manpower, finances, materials, and services. The more details you have about the project, the more accurate is CapEx budgeting. 

Make long-term plans

At the beginning of the CapEx project itself, the decision on whether you will purchase the capital asset with debt or set aside existing funds for the purchase needs to be taken. If it is decided that money is to be saved for the purchase, then it will take a while before acquiring the asset. And, if the decision was to borrow money for the purchase, then the debt is increased and the ability to borrow in the future is also diminished. The choice of using your funds or borrowing depends on the project in consideration.  

Use good budgeting software

Right from the beginning of the project, you need to choose a reliable and practical solution for CapEx budgeting and approval. The choice of software depends on such things as the scale of the project, risk of error, and speed of the program. 

Accurate Capture of data

Accurate data is critical if you want to manage capital projects efficiently. For a realistic budget and insightful reports, the data gathered must be reliable. The level of detail in the budget must be just right. Too much detail will not only take too much time to gather but also might make the budget outdated. On the other hand, too little data will make the budget vague, and, therefore less useful. The key lies in finding the optimal balance. 

Make Clear Policies

Management of CapEx may involve numerous employees, departments, or even regions scattered across different geographies. In order to track the CapEx budget accurately, clear policies must be defined for everyone to follow.

OpEx – What it is

In simple terms, Opex meaning refers to expenses incurred regarding a business’s operational activities. Operating expenses (OpEx) or operating expenditure refers to the costs incurred by a business for its operational activities. In essence, operating expenses are all the costs that a company undertakes to perform its operational activities. 

OpEx is essential for analyzing a company’s performance, hence, it is important for internal and external analysts to identify a company’s OpEx to understand its primary cost drivers and assess management efficiency. Operating expenses take care of the operational activities, but not the investing or financial activities of the company.

Operational expenditures are a company’s key commercial activities in generating revenue. It is important to understand the difference between capital expenditure vs operating expenditure because both are treated differently for accounting purposes. 

Before getting into operational expenses, it is important to understand what operational activities are. Operational activities are essentially primary revenue-generating activities of the business that are not financing or investing activities. These activities cover the commercial activities of the company. For instance, the main operating activity in a manufacturing concern is to produce the product from raw materials, while for a trading concern, it is to buy products from the supplier and sell them to end-users. 

The operational activities are different for different industries. Hence, the classification of an activity as operational also varies in every industry. For example, the purchase of a building is an investing activity in most industries, but for real-estate concerns purchase of a building is intended for resale, hence, an operational activity.

Finance managers classify operational costs as fixed and variable costs. Classifying costs this way enables managers to understand the nature of the expense better. Fixed costs remain the same no matter the production level, while variable costs vary with the number of products/services that a company produces. Rent, lease payments, and insurance expenses may be classified as fixed costs. On the other hand, labor and raw material costs, and sales commissions may be classified as variable costs. 

It is important to note that the same category of an operating expense may be considered a fixed or variable cost, depending on the context. Let us take wages as an example, wages for a full-time employee may be considered as a fixed cost, while wages for an assembly line factory worker may be identified as a variable cost. What is included in Operating expenses? 

Operating expenses include –

• Payroll for staff (excluding labor for manufacturing)
• Insurance
• License fees
• Research
• Rent
• Accounting fees
• Marketing
• Building maintenance and repairs
• Utilities
• Attorney fees
• Vehicle expenses
• Travel expenses
• Office Supplies

An increase in operating expenses and overheads diminishes the profits of the business. These costs are scrutinized by the accounts department at all times because these are more variable than the non-operating costs. The senior management in a company tries to reduce operating and utility costs by outsourcing some areas of work or allowing existing staff to work from home. Management also implements money-saving techniques like automating parts of the CapEx Opex processes to make it more streamlined.

Importance of Operating Expenses

Operating expenses are important for the business because they help evaluate the company’s costs, reduce operating costs, and manage stock accurately. The level of cost that a company needs to generate revenue is highlighted by the Opex. When a company incurs a comparatively higher Opex as a percentage of sales compared to the competition, then that might indicate they are less efficient at generating sales. 

The disadvantage of looking at the company’s Opex is that it is an absolute number and not a ratio. It is unreasonable to use Opex as a metric to compare firms that belong to the same industry. 

CapEx vs OpEx

Businesses incur a lot of expenses, from the rent they pay to the cost of raw materials for their products. To simplify all these costs, all these expenses must be arranged under different categories. The two main categories of business expenses are capital expenditure and operational expenditure.

The basic Opex vs Capex difference lies in the way management may approach these expenses. Before we get into the capital expense vs operating expense difference, it is important to understand the difference between expenditure and expense.

Expense refers to the cost of goods or services that are used up in the process of generating revenue. Expenditure on the other hand refers to the outflow of cash or assets for making a purchase. Expenses are classified as operating or non-operating, while expenditures are classified as capital or revenue. 

Further in the Opex vs Capex debate, we must consider that Capex is more expensive and labor-intensive, and requires more time to reap the rewards. Opex is often cheaper and more flexible to incur. It is important to understand the Capex versus Opex differences to know how a company strategically approaches both types of expenditure. 

Before getting into the differences between Capex and Opex, let us consider the similarities between the two. Both capital and operating expenses represent the outlays by the organization. Both these expenses are usually acquired in exchange for cash and go through a similar purchasing process. Both CapEx and OpEx go through solicitation of a bid, contracting, legal review, final payment, and receipt of purchase. 

Both these expenditures reduce the net income of the organization. Opex is immediately depreciated, while Capex is depreciated. Planning for both types of expenses is also similar. Both these expenses require a budget, long-term planning, and a finance manager to oversee plan, and report them. 

The key differences between CapEx and OpEx are listed in the table below.

Why do the Capex vs Opex Differences Matter?

There is no denying that the Capex process can be complex and convoluted, and the Opex process is short and simple. Businesses usually blur the line between these two types of expenses, to push more expenses into the Opex category. However, it must be borne in mind that these two types of expenditures have different effects on the business’ budgeting, reporting, cash flow, and bottom line. 

The main confusion between Capex and Opex arises mainly from the tax perspective. So in order to have a clear distinction between the 2 types of expenditures, the following points must be borne in mind –

• Urgency – what is the risk of taking no action?
• Benefits – What are the qualitative and quantitative benefits?
• Risk – what is the level of finance risk?
• Strategic alignment – Is it aligned with the overall direction of the business? 

Automating CapEx and OpEx Approvals

From the above discussions, the complexity and convoluted nature of the CapEx process requires a solution that streamlines the process by eliminating bottlenecks, improving speed, and enabling smarter decision-making. Streamlining the Capex process will make the budgeting and financial processing more efficient. 

Overhauling the Capex process in the organization is a challenging process, with multi-departmental review and approval, a multi-stage affair with plenty of stakeholders to please. Rather than having a proprietary platform for each department, it is better to have an end-to-end Capex solution.

An end-to-end CapEx solution  – 

• Facilitates seamless communication
• Drives collaboration
• Reduces bottlenecks
• Simplifies the process
• Provides data to optimize the next round of CapEx

Automating the CapEx workflows is the most effective way to streamline CapEx and OpEx workflows. Moving away from manual processes for CapEx and OpEx can minimize errors and accelerate workflows.

What does automation do to Capex and Opex workflows?

• Streamlines submission of workflows with necessary information and documentation
• Accelerates request approval with the help of intuitive dashboards that show relevant information
• Facilitates sending requests to alternate approvers, and also sequential and parallel approvals
• Facilitates escalation of requests to higher level approvers depending on the amount requested
• Generates audit trails automatically
• Integrates with financial reporting systems for improved transparency

Cflow is a no-code BPM solution that provides all of the above features, and many more features that improve the efficiency of CapEx and OpEx approvals.  To create approval workflows, you simply have to drag and drop visual elements with the visual form builder. Multi-level approvals and task dependencies can be easily incorporated into workflow.

The reporting and analytics feature in Cflow is extremely useful for management to make data-driven decisions. Critical business processes like CapEx approvals can be easily automated with the BPM workflow automation solution like Cflow.