Capex definition
/What is Capex?
Capex, short for capital expenditure, refers to the funds a business uses to acquire, upgrade, or maintain physical assets such as buildings, equipment, or technology. These expenditures are typically long-term investments that support the company’s operations and future growth. Unlike regular operating expenses, Capex is capitalized on the balance sheet and then depreciated over the useful life of the asset. Companies often plan Capex carefully, as it requires significant cash outflows and impacts budgeting and financial forecasting. Examples of Capex include purchasing new machinery, upgrading IT systems, or expanding facilities.
How Capex Varies by Industry
The level of capex required to operate a business varies dramatically by industry. For example, a professional services business, such as a tax accounting firm, may not have any capex at all. Conversely, an oil shipment business must invest enormous sums in pipelines, tankers, and storage facilities, so capex comprises a large part of its annual expenditures.
Capex Analysis
The acquisition of a capex item generally requires a formal analysis and approval by management, with more expensive items possibly even requiring the approval of the board of directors. This analysis typically includes a review of the discounted cash flows associated with a requested capex expenditure; an alternative is to base the investment decision on the impact of the expenditure on the constrained resource of a business. If the investment will increase the capacity of the constrained resource, then the overall throughput of the business will be enhanced.
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Accounting for Capex
The accounting for capex varies, depending upon the nature of the asset. The two alternatives are noted below:
Capex treatment of assets. If an expenditure is greater than the capitalization limit of a business, and is for an asset whose utility will be used up over a period of time, then record it as a fixed asset and depreciate it over the useful life of the asset. You can assign it the standard useful life and depreciation method for all of the other assets within the asset classification to which it is assigned, for consistency.
Capex treatment of expenses. If an expenditure is less than the capitalization limit or the result only maintains an asset in its current condition, then charge it to expense as incurred. Most expenditures are so small that they fall into this accounting treatment classification.
Analysis of Capex
Outside analysts may track the level of capex reported by a company from year to year, to see if it is investing a sufficient amount to maintain company operations. This analysis is not always accurate, for the reasons noted below.
Impact on capex of step costs. A company may have needed to buy an unusually large capex item, such as an entire production facility, which it will not have to duplicate in every subsequent year. Thus, the capex trend line tends to be lumpy, depending on the needs of the business in any given year.
Impact on capex of acquisitions and disposals. Larger companies may routinely buy and sell subsidiaries, along with their fixed assets. A high level of churn makes it difficult to ascertain the true amount of annual capex of the parent company.