Understanding the difference between capital expenditure (CapEx) and operational expenditure (OpEx) is essential for any business owner, especially when it comes to making decisions about growth. Simply, CapEx refers to investments in business assets, while OpEx accounts for the ongoing, everyday operational costs of the business.
Here, we take a closer look at how CapEx and OpEx differ, highlighting the importance of keeping track of both types of expenses to achieve optimal growth for your business.
Understanding CapEx vs. OpEx
Any business expense or cost can be categorised as either a capital expenditure or an operational expenditure.
Capital expenditure (CapEx) explained
CapEx refers to investments in assets or projects that provide long-term benefits and typically have a significant upfront cost, such as buying machinery, building a new facility, or developing software. These expenditures are capitalised on the balance sheet, which means spreading the expense over multiple financial years, during which time they will also depreciate in value.
While CapEx as a cost may be spread over multiple years, it must always be included in a company's current balance sheet, says Dr. Eric Boahen, Senior Lecturer and Cluster Lead, Accounting, Finance and Economics at the Royal Docks School of Business and Law at the University of East London: “All capital expenditure items are listed on the balance sheet or statement of financial position.”
Before committing to any CapEx investment, however substantial, a thorough analysis should be carried out to ensure that it will provide long-term benefits with minimal risk. Many companies ring-fence their CapEx budget annually. This helps control costs and will routinely reassess their capital investments to ensure that they continue to deliver value for their business.
Examples of CapEx
CapEx are business assets or investments with long-term value. The following are common examples of capital expenditures, says Boahen: “Purchase of plant equipment and machinery, building improvements, purchase of computers and motor vehicles.” Other examples of CapEx include land purchases and software upgrades.
Operating expenditure (OpEx) explained
In contrast to CapEx, OpEx represents day-to-day operational costs necessary to keep the business running, this includes salaries, rent, utilities and maintenance of equipment and machinery. OpEx is deducted from revenue in the period incurred, directly impacting profitability. OpEx tends to include a firm's recurring expenses. OpEx is more flexible than CapEx and easier to reverse if necessary. If you began a social media advertising campaign, for example, and found that it wasn’t delivering the expected results, you could potentially halt the campaign.
Boahen adds: “All operating expenses appear on the income statement. For tax purposes, some operating expenses are deducted from the profits in the year when the expenses are incurred. Such operating expenses are tax-deductible or allowable expenses.”
Examples of OpEx
As everyday business expenses, examples of OpEx are employee wages, payroll, human resources, research and development, rent and insurance. Other examples include advertising, sales and marketing costs, legal fees, repairs and travel costs, interest paid on loans, office supplies and utility bills.
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CapEx vs. OpEx: the key differences
The most important difference between CapEx and OpEx for any business is how they are treated in financial reporting.
“CapEx is treated as an asset on the balance sheet, but OpEx is treated as an expense on the income statement," says Boahen.
"CapEx is recognised as an asset and is depreciated over its useful life, but OpEx is expensed immediately and not depreciated over any useful life. CapEx often has a more complicated approval process requiring high-level approval, but OpEx often has a straight-forward, pre-approved process in place.”
There are instances where CapEx and OpEx can seem very similar and how you pay for it will determine how it is categorised. For example, if you buy computers for your business, this would be defined as CapEx, but if you rent them, it becomes OpEx. For financial management purposes, it is essential that each expense is correctly defined.
Investing in CapEx vs. increasing OpEx
The structure and products or services offered by your business will impact how much you spend on CapEx and OpEx. For example, a services firm, such as an estate agency, will likely have lower CapEx than a manufacturer who has to invest heavily in factory equipment and materials to produce their products.
A firm's success depends on managing and monitoring both CapEx and OpEx, says Boahen. “A firm that is growing or wants to expand must invest in both CapEx and OpEx. A firm grows better by investing more effectively in CapEx. A growing firm must efficiently manage its OpEx through cost control and cost reduction strategies. However, firms that are facing cashflow problems should avoid investment in CapEx in the short-term and invest their limited available funds in OpEx to keep the business operational.”
Every business's expense needs are different. Some businesses may operate remotely with staff spread around the world working from laptops and mobile phones, involving minimal capital expenditure. Others may have huge factories, extensive proprietary technology and millions of pounds of assets that need servicing. Only by analysing the needs of your specific business, can you optimise your investment in CapEx and OpEx and prepare for growth.
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