Understanding Capital Expenditure (CapEx) Process
Capital expenditure is funds used by the business to procure, upgrade, and maintain assets required to run the business. Expanding business operations requires capital expenditure. Undertaking new projects or investments by a company is taken care of by the CapEx budget. Capital spending is undertaken to increase the scope of operations or increase the economic benefit to the operations.
CapEx is also referred to as capital spending includes all the business expenses towards the purchase of new land, equipment, plants, warehouses or buildings, furniture or fixtures, software, business vehicles, or intangible assets like patents or licenses. Operational expenses (OpEx) on the other hand are the operating expenses that the company incurs for day-to-day operations. These are not included in capital expenditure. Capital expenditure examples include capital spent for property, plant, and equipment (PP&E) like office buildings, land, equipment), office infrastructure like computers, furniture, other machinery), and intangible assets like licenses, copyrights, and patents.
All purchases are not classified as CapEx, only when the expense exceeds the capitalization limit, it is classified as a capital expense. Capitalization limit is usually set by businesses in order to decide if a purchase can be classified as a fixed asset. Another way to classify purchases as capital expenditure is to consider the revenue-generating capacity of the asset or its contribution in reducing the production costs. The procured asset must have a productive purpose and a useful life spanning more than one accounting period. In accounting lingo, the purchase is recorded as a capital asset rather than an expense, and costs incurred are recorded as depreciation and charged to the expense account.
Let us understand capital investment depreciation with an example. The purchase of machinery worth 60, 000 USD is recorded in the balance sheet as capital expenditure. As the machine starts aging, its value starts decreasing. The depreciation calculation is applied to the machinery and at the close of the accounting year the reduced value is shown as depreciation value in the financial statement.
Capital expenditure is undertaken to improve the operational efficiency of the business, increase long-term revenue, and improve existing assets. Capital expenditure is closely monitored by investors and analysts because of the long-term impact on businesses’ health.
Are capital expenditures tax deductible? Although not directly deductible, Capex can contribute to the indirect reduction of the company’s tax payable through the depreciation value of the fixed assets. The depreciation on fixed assets purchased via capital expenditure helps in reducing income taxes.