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What are capital expenditures (Capex)?

Capital expenditures are funds a company uses to obtain, maintain and improve long-term assets for the company.
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Most companies have long-term assets and physical assets that are necessary to maintain business operations or to create a positive working environment. Capital expenditures or Capex are funds a company will use to acquire more of these assets, as well as to maintain and upgrade the ones the company already has. Long-term assets are usually fixed and physical items such as property, buildings, technology, infrastructure and equipment.

There are two main types of capital expenditures: (1) expenses that maintain the current level of spending in the company and (2) expenses that enable future growth. A capital expenditure can be something a company uses to continue as they are, or it can be funds to help make growth possible. There is a wide variety of assets that can be considered for both types of capital expenditures. Some of these assets include:
graphic outlining the types of capital expenditures
  • Buildings
    These buildings can be office space, but they can also be manufacturing plants, storage spaces and more.
  • Equipment
    Equipment can include tools used to manufacture goods, but it can also include vehicles that are used for business purposes.
  • Computers and servers
    Most companies rely on technology to operate. Computers and servers are assets that a company needs, so these expenses are capital expenditures. Software can also be a capital expenditure.
  • Furniture
    Furniture makes a space usable for both staff and customers, so it can also be considered a capital expenditure.
  • Land
    If a company buys land and maintains it for business purposes, it can be a capital expenditure.

Companies need to decide how much to invest in capital expenditures, so it is important to understand why capital expenditures are such a crucial decision. These are some of the reasons why understanding capital expenditures is important:

Long-term effects

Capital expenditures can be the driver of the direction a business takes. With long-term organisational goals in place, companies can make decisions about capital expenditures that then drive how much potential for growth there will be later. Essentially, the current range a company has is the result of past capital expenditure decisions. So, making wise capital expenditures decisions can help a company create the long-term effects necessary to grow.

Irreversibility

It is particularly important to carefully consider capital expenditures because they are essentially irreversible without loss. Most capital expenditures are designed to specifically meet a company’s needs, so they are not easy to reverse. Taking time to fully understand where the company should invest in capital expenditures can make the irreversibility beneficial.

High initial costs

Thoroughly considering capital expenditure is crucial, as it often comes with high initial costs. For example, setting up a new building is costly with the down payment, rent costs, utilities and other expenses. These high costs mean that it’s incredibly important that companies determine the right capital expenditures, so the high initial costs are invested in assets the company truly needs.

Depreciation

Once an asset is put into place and is used, it depreciates in value throughout its lifespan. Since these assets depreciate, it is important to invest capital expenditures in a way that benefits the company and its long-term goals.

Capex and Opex are often used in similar contexts, but what is the difference between them? “Opex” refers to short-term operating expenses that are used to cover the ongoing costs of running a business. Operating expenses typically include costs that can be written off in one fiscal year, so they do not appear on financial statements for multiple years or periods of time. Capital expenditures will appear for multiple periods of time because they are long-term investments.

Operating expenses will be used to operate the business and are accounted for within the period in which they are incurred. Operating expenses also make up much of a company’s ongoing costs. Capital expenditures typically have their own budget and will remain on an assets sheet for multiple accounting periods. So, while these terms are used in similar contexts, they are not the same.

How are capital expenditures calculated?

Calculating capital expenditure is important because it can show how much a company is currently investing in Capex and where the company may need to adjust for future operations. But how can someone calculate capital expenditures? This is the process of calculating capital expenditures: 

  • Retrieve all necessary financial information and statements. These include cash flow statements and income statements and any other financial information that might have data on assets.  

  • Subtract current fixed assets from the value of fixed assets from the fiscal year before. With financial statements like Apple’s, these two numbers are both available to make the calculations simple.

  • Subtract the accumulated depreciation. Assets depreciate in value, and it’s important to include that in calculations.  

  • Add the current number to the total depreciation value. Then that final figure will be the total capital expenditure for the company for the last year.

This process can be expressed as a formula for calculating capital expenditures that can be useful for companies looking to better understand their current capital expenditures. 

The formula can be written as:  

Capex = ΔPP&E + Current Depreciation

PP&E represents change in property, plant and equipment. However, if a company chooses to calculate capital expenditures, every organisation should understand how much they spend in capital expenditures and where there is potential for growth.

What are the challenges associated with capital expenditures?

Capital expenditures are important, and they require thorough analysis and planning. But there are some complexities and challenges that come from working with capital expenditures. These are three common challenges that often arise with capital expenditures:

Measurement problems

While the formula and process for calculating capital expenditures seem simple, they can be complex. The accounting processes necessary to identify, measure and estimate costs associated with capital expenditures can be complex. That can lead to measurement problems.

Unpredictability

When a company invests in a capital expenditure, they are doing so based on what seems to be a predictable outcome. But business is always uncertain, and there can be a level of unpredictability, and losses can occur with capital expenditures. Even the best forecasts can be incorrect, which is what can make capital expenditures complex. Organisations must prepare for potential losses, knowing they can never eliminate them.

Temporal spread

Capital expenditures are spread across years and many accounting periods. That can also mean that the benefits from capital expenditure investments may be spread out as well and appear less significant. This temporal spread can also lead to problems with estimation.

While there are challenges with capital expenditure, there are best practices that organisations can utilise to use capital expenditures effectively in a way that benefits their long-term goals. These are some of the best practices to consider:

  • Build in adequate preparation
    As discussed earlier, capital expenditures are hard to reverse and come with high investment costs. That is why it’s essential to use adequate preparation time to set a company up for success. Some important pieces to have in place before moving on include budgets, the scope of the project, deadlines and proper approval.

  • Plan long-term
    Capital expenditures are to help a company prepare for its future and to have the tools necessary to succeed. Organisations should plan long-term to ensure that the capital expenditures are the right ones for the company. Companies want to make sure finances are in line to purchase what is needed now, and they also want to ensure that they are choosing capital expenditures that will benefit the company in the future.

  • Collect accurate data
    Data is a reliable way to determine if a process is working. It is important to collect accurate data about capital expenditures to create a realistic budget and to generate valuable information for future endeavours.

  • Use the right software
    Using strong and reliable software helps reduce the risk of errors with capital expenditures. Software can help manage the risk of error and provide the company with tools needed to manage capital expenditures.

  • Create standards
    Having clear policies in place makes capital expenditures simpler, especially for large organisations with many departments or even cross-country locations. Creating a template can also be beneficial. Teams can then use the template to create their own capital expenditures project.

  • Plan for “what if” scenarios
    There is nothing in business without some level of risk. There is a level of risk that comes with capital expenditures. Companies that want to be prepared for any situation and stay on top of capital expenditures will plan for “what if” scenarios along the way. Preparing cannot completely eliminate the risks, but it can create an established plan for what to do when something does go wrong.

Capital expenditures are long-term assets a company has that a company needs to operate. They might include the office space or the equipment needed to make a product or even the computers employees use. Carefully consider where to invest in capital expenditures because they come with challenges and risks. But there are some best practices that can help organisations work with capital expenditures.  
 
ServiceNow offers a comprehensive suite of management tools, including Software Asset Management, Hardware Asset Management, Cloud Insights, and Enterprise Asset Management—asset management software optimised and working together on a single, centralised platform. Easily track, optimise and enhance all your assets, including capital expenditures, to streamline your asset management processes, reduce costs and improve overall operational efficiency. ServiceNow gives you the tools and support you need to get the most out of your most valuable assets.

Learn more about ServiceNow Asset Management; talk to an expert today and take your capital expenditures management further. 

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