The CapEx vs OpeEx Debate – Why and How does It Matter to Your Business?
Key takeaways
- The basic Opex vs Capex difference lies in the way management may approach these expenses.
- The major difference is in the categories of expenditure that each handles. Opex entails all the day-to-day, operational costs. Capex is the long-term expenses and investments.
- It is important to understand the difference as their treatment differs in urgency, benefits, risk, and strategic alignment.
- Automating the CapEx workflows is the most effective way to streamline CapEx and OpEx workflows.
Capex vs. Opex
The basic Opex vs Capex difference lies in the way management may approach these expenses and its treatment. Capex covers all the expenses like investments in buildings, equipment, vehicles, patents, etc. Opex, on the other hand, covers the operational costs such as rent, utilities, salaries, etc.
Table of Contents
Keeping track of cash flow, expenses, and accounting transactions is necessary for uninterrupted business operations. Capital expenditures (CapEx) and Operational Expenses (OpEx) are two of the most important elements of business operations. CapEx and OpEx are both expenses that help a company carry out its operations, however, CapEx and OpEx differ in their scope. Businesses have 2 options when it comes to procuring new equipment, capabilities, and software –
Obtaining new capabilities and equipment as CapEx
Or
Obtaining them as OpEx
Dividing business expenses into different categories, helps businesses keep track of the expenditure. This blog explores the CapEx and OpEx meaning, CapEx vs OpEx differences, and effective ways to automate CapEx and OpEx differences.
Table of Contents
CapEx – What it is
Capital expenditure (CapEx) is the expense either in cash or credit towards long-term physical or fixed assets used in business operations. The expenditures are capitalized on the balance sheet and are considered as an investment by the company. CapEx is important for growth of the business and for maintaining business by investing in new equipment, property, and technology. Financial analysts and investors need to focus on the company’s capital expenses because they do not appear on the income statement but have a significant impact on the cash flow.
Both the long-term and short-term financial standing of the organization is substantially affected by capital expenditures. Therefore, making wise decisions on capital expenses is critical for the financial well-being of the organization. Several companies maintain the levels of their historical capital expenses to show investors that they are committed to investing in the growth of the business.
The decision to capitalize on an expense should be made based on how long the benefit of the expense is expected to last. When the benefit lasts less than a year, the expense can be included in the income statement. If the benefit lasts more than a year, it must be capitalized as an asset on the balance sheet.
For instance, the purchase of office supplies would not be capitalized, since the benefits wouldn’t go beyond a year. The purchase of a building, for example, would provide a benefit of more than a year. This would be deemed as a capital expenditure. There are mainly two forms of capital expenditures –
Maintenance Capex – Expenditures required to maintain current levels of a company’s operations.
Growth Capex – Expenditures that provide an impetus for an increase in future growth.
Capital expenditures are classified as an asset on the balance sheet. To move the asset off the balance sheet in due course, it must be expensed and moved through the income statement. Accountants expense assets onto the balance sheet via depreciation.
Several depreciation methods can be used based on the preference of the management team. Over the life of an asset, total depreciation will be equal to the net capital expenditure. Free cash flow is an important metric in corporate finance. Capital expenditure is an important factor in determining free cash flow.
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.
| Attribute | CapEx | OpEx |
| Definition | Capital expenditures are those that create future benefits. | Operating expenditure refers to expenses that are incurred in the course of routine business operations. |
| Time | Capital expenses are incurred when a business spends money to buy fixed assets or to add value to an existing asset with a useful life beyond a tax year | Operational expenses are incurred almost on a daily basis like sales, admin expenses, and general expenses |
| Other names | Capital expenditure or capital expense | Operating expense, Revenue expenditure, Operating expenditure |
| Accounting implication | Cannot be fully deducted in the period when they are incurred. Tangible assets are depreciated and intangible assets are amortized over time | These expenses are fully deducted in the accounting period during which they are incurred |
| Reporting | Capex is reported in the balance sheet as an asset | Opex is reported on the income statement as an expense |
| Association | CapEx is usually associated with depreciation and accumulated depreciation accounts | Opex is associated with current accounts |
| Benefit | This expense holds long-term benefits for the company | Holds short-term value and almost nil benefit for the company |
| Recognition | Recognized as an asset through depreciation over its useful life | Expensed immediately and not depreciated over any useful life |
| Cash dealing | Deals with high cash amounts | Deals with smaller and frequently incurred cash amounts |
| Examples | Development of buildings, vehicles, land, or machinery that is expected to be used for more than one year | Repairs, salaries, supplies, and rent. All these expenses provide short-term benefits for the company |
| Procurement | Purchasing rarely takes the lead, it only assists in the procurement of the item | Everyday items are bought on a regular basis by maintaining minimum stock levels |
| Preference (Income tax) | Capex is not preferred for income tax purposes, as the expense is not deducted in the tax year | Opex is preferred over Capex, as it is incurred as daily operations and is deducted during that tax year itself |
| Cash flow | Capex does not reflect in operating cash flow. They reduce the free cash flow | Opex has a direct impact on the operating cash flow. These expenses reduce the operating cash flow |
| Complexity | Capex processes are complex and lengthy | Opex processes are comparatively simple and shorter |
| Approval workflows | Capex being a daily complex process entails an intricate approval workflow | Opex is a straightforward process that entails a simple and short approval process |
| Challenges | Require a large initial outlay of capital or money | The outlay for opex is comparatively lesser |
| Finance | Capex is financed by debt | Opex is financed by cash owned by the business |
| Requests and approvals | Capital expenditure is through a lengthy and convoluted approval and reporting process | Opex approvals and reporting are usually a single-step process |
| Budgeting | CapEx approvers need to take into account the company budget and future spend | Opex being lower in value and requiring urgent approval, the company’s budget and future spending are not considered for approval |
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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.
Conclusion
Business expenses are classified as CapEx and OpEx for the sake of easy tracking and expense management. Owing to the complexity of the CapEx process, businesses tend to blur the Capex vs Opex distinction. Knowing the Opex vs Capex differences and similarities is important for a business trying to streamline its finance budgeting and planning.
Automating the CapEx approval process is the most effective way to streamline the process. Using a robust BPM tool like Cflow to automate the CapEx and OpEx workflows accelerates approvals and improves the accuracy of the CapEx process. Try Cflow for free by signing up now.
FAQs
1. What is the difference between CapEx and OpEx?
In simple terms, CapEx is a business cost that yields long-term benefits for the business. OpEx on the other hand are costs that have much shooter cost benefit for the business. Knowing the CapEx vs OpEx is essential for every business.
2. Which is a better model – CapEx or OpEx?
From the tax perspective, Opex scores over Capex. In reality, these models cannot be compared, as they are 2 different ways of classifying costs. For companies that are looking to make future investments, CapEx must be considered. If a company wants to preserve capital and maintain flexibility, considering Opex is a better option.
3. How are CapEx and OpEx reported?
Capex is reported on the balance sheet as a capitalized asset. Since most Capex assets depreciate over their useful life, the expense related to the asset is recognized each year evenly over its useful life. Opex is reported in the income statement and is expensed immediately. There is no long-term value to Opex, so it must be expensed in the period in which the cost is incurred.
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