September 27, 2020

CapEx vs OpEx explanation

CapEx versus OpEx. Capital Expenditures versus Operating Expenditures. There is a finance and accounting aspect to the terms CapEx and Opex, as well as a business model aspect. Let’s discuss both, and walk through some examples of how the terms CapEx and OpEx are used.

CapEx is Capital Expenditures. OpEx is Operating Expenditures. What these terms have in common is the word expenditures, you are spending money, but in different ways.

Capital Expenditures. As a working definition of CapEx, this is money spent by a business or organization to acquire or upgrade fixed assets, such as buildings, machines and equipment.

Operating Expenditures. If CapEx is the upfront investment to buy a fixed asset, then a working definition of OpEx is the ongoing spending to keep the fixed asset running.

For an expenditure to be considered as CapEx, you have to own an asset. There is a threshold level for expenditures to qualify as CapEx: there must be a useful life of more than one year, and the asset value must be more than a minimum amount. I have worked with a company where this minimum was $2500, and others where it was $7000. Please check with the finance department of your company on what your minimum level is.

How about that part of maintenance where you are improving the performance of a machine and increase its capacity? What about software developed for internal use? What about the development phase of R&D? You could argue in all three cases that future economic benefits are generated by these projects, and according to the matching principle in finance it would be appropriate to capitalize these costs, and subsequently depreciate or amortize these assets over their useful life. Each of these cases will have to be evaluated carefully against current US GAAP or IFRS rules (depending on where your company is listed), and you will have to meet very strict criteria to apply a CapEx treatment.

How does CapEx affect the financial statements? Let’s take a look at the balance sheet, the income statement and the cash flow statement, when we answer the question “does this expenditure qualify for CapEx (it meets the capitalization criteria) or it does not qualify as CapEx?”.

First of all, the CapEx spend is a cash outflow recorded in “Cash From Investing Activities”. On the balance sheet, it gets accounted for as an asset, in the Plant and Equipment category. Over the years of its useful life, the asset gets depreciated, and the depreciation charge hits the income statement or P&L in each of the years of the assets’ economic life. I will link to my video about deprecation if you are interested in learning how that works:

Do you go for the upfront CapEx investment to own servers for your datacenter, where you are unsure how much capacity you will actually need, or do you pay a monthly OpEx fee for an external cloud service where it’s pretty much “pay as you go” and “spend what you use”? I can’t give you a “one size fits all” answer to this question, it’s really something that an IT manager and a finance manager should analyze together. Risk and scale should be part of this conversation. The evaluation is a variation of the age-old “own versus use”, “buy versus rent”, “buy versus lease” discussion, which is more relevant than ever before in these days of ubiquitous digital devices and tools, disruption of mobility models through Uber and others, and disruption of the travel and leisure models through Airbnb.

This video discusses the impact of CapEx versus OpEx on the balance sheet, income statement, and cash flow statement, as well as ratios such as ROA. For more information on ROA and DuPont analysis, watch

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers training in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

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