CapEx vs. OpEx: Key Differences Explained

CapEx vs. OpEx: An Overview

Companies often face a variety of financial needs that are categorized as capital expenditures (CapEx) or operating expenses (OpEx). CapEx involves major, long-term purchases like buildings and equipment. OpEx, however, covers routine, day-to-day expenses like salaries and rent. Understanding the distinctions can clarify their financial impacts and tax treatments.

Understanding Capital Expenditures (CapEx)

Capital expenditures (CapEx) are purchases of significant goods or services that will be used to improve a company’s performance in the future. They are typically for fixed assets like property, plant, and equipment (PP&E). For example, if an oil company buys a new drilling rig, the transaction would be a capital expenditure. Capital expenditures can also be for intangible assets, such as patents and other forms of technology.

Capital expenditures serve several purposes, such as:

• Growing the business by adding new sectors or services
• Replacing older or outdated equipment
• Expanding the useful life of an existing fixed asset
  

CapEx can be externally financed, which is usually done through collateral or debt financing. Companies issue bonds or take out loans to fund their capital expenditures or they can use other debt instruments to increase their capital investment. Shareholders who receive dividend payments pay close attention to CapEx numbers, looking for a company that pays out income while continuing to improve prospects for future profit.

Reporting Capital Expenditures

Capital expenditures are listed on the balance sheet under the PP&E section. CapEx is also listed in the investing activities section of the cash flow statement.

Capital expenditures for fixed assets can be depreciated over time to spread out the cost of each asset over its useful life. Depreciation is helpful for major capital expenditures because it allows the company to avoid a significant hit to its bottom line in the year when the asset was purchased.

Examples of Capital Expenditures

CapEx represents the company’s spending on physical assets. The following are common examples of capital expenditures:

• Manufacturing plants, equipment, and machinery
• Building improvements
• Computers
• Vehicles and trucks

Understanding Operating Expenses (OpEx)

Operating expenses are the costs that a company incurs for running its day-to-day operations. As such, they don't apply to any costs related to the production of goods and services. They must be ordinary and customary costs for the industry in which the company operates.

Operating expenses arise from regular business activities. Companies aim to improve efficiency and productivity by increasing output relative to these expenses, making operating expenses a key indicator of efficiency.

Examples of Operating Expenses

The following are common examples of operating expenses:

• Rent and utilities
• Wages and salaries
• Accounting and legal fees
• Overhead costs such as selling, general, and administrative expenses (SG&A)
• Property taxes
• Business travel
• Interest paid on debt
• Research and development (R&D) expenses
  

Reporting Operating Expenses

Companies report operating expenses on their income statements. Unlike capital expenditures, companies can deduct these costs from their taxes for the year when the expenses were incurred. However, they cannot be depreciated over time.

Key Considerations for CapEx and OpEx

Both capital expenditures and operating expenses represent outlays by the company. Both are usually acquired in exchange for cash and may go through a similar purchasing process. This can include:

• Solicitation of a bid
• Contracting
• Legal review
• Orchestration of financial payment
• Receipt of the purchase

Both CapEx and OpEx reduce a company’s net income, though they do so in different ways. OpEx is expensed immediately, while CapEx is depreciated.

Companies can also plan for both types of expenses similarly. Each type of cost may have its own budget, forecast, long-term plan, and financial manager to oversee the planning and reporting of the expense.

Key Differences

Capital expenditures are major purchases that will be used beyond the current accounting period in which they’re purchased. Operating expenses represent the day-to-day expenses designed to keep a company running. Because of their different attributes, each is handled distinctly.

OpEx are short-term expenses and are typically used up in the accounting period in which they were purchased. This means OpEx is more often paid for in the period when it is acquired. CapEx may be paid for in the period when it is acquired, but it may also be incurred over some time if the CapEx is related to a development project. For example, the building of a new warehouse may result in 1,000 transactions over six months, all of which are collectively considered CapEx.

CapEx and OpEx are reported differently, as CapEx resides on the balance sheet and OpEx resides on the income statement. This is due to the difference in their accounting treatment. In addition, the method of translating the expenditure as an expense is different. CapEx is often associated with depreciation and accumulated depreciation accounts, while OpEx is not.

The Bottom Line

Capital expenditures (CapEx) involve major, long-term investments like equipment or buildings, offering benefits beyond the current year and typically appearing on the balance sheet. Operating expenses (OpEx), such as rent and salaries, cover immediate operational needs and are recorded on the income statement. While OpEx can be deducted immediately for tax purposes, CapEx is usually depreciated over time. Understanding the distinct roles and financial impacts of CapEx and OpEx is crucial for a company's strategic planning, ensuring both short-term operational efficiency and long-term growth potential.