Capital Expenditure refers to funds a company spends to purchase or improve long-lived tangible assets—such as land, buildings, machinery, and equipment—that will benefit the business over multiple periods. These expenditures are capitalized on the balance sheet rather than expensed immediately.
Why is Capital Expenditure Important?
Capital Expenditure is important because it:
Drives Growth and Capacity: Enables companies to expand production capabilities, enter new markets, and support increased demand.
Maintains Operational Efficiency: Keeps existing assets in good condition, reducing downtime and extending useful life.
Influences Financial Metrics: Affects future depreciation expense, asset base, and cash flow forecasting, impacting profitability and valuation.
How is Capital Expenditure Calculated?
On the cash flow statement, CapEx is reported in the investing activities section as:
Capital Expenditure = Cash Paid for Purchases and Improvements of Fixed Assets
Key components include:
Acquisition Cost: Purchase price of new assets or major improvements.
Installation and Delivery Fees: Costs incurred to install and prepare assets for use.
Capitalized Interest: Interest costs during asset construction when capitalization criteria are met.
Additional Considerations
Capitalization vs. Expense: Only expenditures that provide future economic benefits are capitalized; routine repairs and maintenance are expensed as incurred.
Depreciation Impact: New assets increase depreciation expense over their useful lives, affecting income statements in future periods.
Budgeting and Approval: Companies typically set CapEx budgets and require board approval for significant projects, balancing growth needs with cash availability.