Company's Financial Accounting
What is OPEX and CAPEX?
Capital and operating expenses: what is the difference?
Successful business management largely depends on the correct accounting of all costs of the enterprise associated with its activities, as well as the optimization of all these costs. There are various classifications of expenses, however, the main types of costs of any enterprise are divided into capital and operating.
In the process of preparing the financial statements and the budget, the company will certainly encounter such concepts as OPEX and CAPEX. It is exactly that terms which designate capital expense or capital expenditure - CAPEX (in Finnish, investointikustannukset, pääomakustannukset), and operating expense or operating expenditure - OPEX (in Finnish, operatiiviset menot, käyttökustannukset).
What is CapEX? Capital expenditure
CAPEX refers to company's expenses and investments associated with physical goods, i.e. the purchase of the goods. Capital expenditures, as a rule, are
- one-time costs (irregular) related to doing business,
- expenses referred to the purchase of fixed assets (new equipment, real estate, transport, furniture, buildings, patents, technologies, etc.) and intangible assets,
- expenditures for modernization and updating of existing assets,
- costs for construction of factories, offices, warehouses, etc.
Capital expenditures are а certain basis for business and, as a rule, their main hallmark is the length of use and the lack of regularity. The purchase of assets, which the company will use more than a year, are very likely may be classified as capital expenses. However, the classification of costs often depends on the specifics of the enterprise, so, in each industry there are different types of expenditures.
Briefly, CAPEX is the investments in a company’s property, equipment and its renewal. CAPEX is used to improve a company's performance in the future. The increase in these costs is often a positive factor and sign for the business, as this leads to an increase in capitalization and is a guarantee of the company's competitiveness. In case the company already has a certain volume of fixed assets, but along with this there are no capital investments, this will inevitably lead to progressive depreciation and obsolescence of these assets over time, and, as a result, to the uncompetitiveness of such an enterprise.
Taking into account the fact, that CAPEX expenses and dividend payments are financed from the net profit received, it is necessary to observe а balance between investments in business and payments to shareholders. Since the more funds are spent on capital expenditures, the less will be left for dividend payments and vice versa.
In accordance with International Financial Reporting Standards (IFRS16), the acquisition of property, plant and equipment (fixed assets) should be classified as capital expenditure subject to the following conditions:
- assets are intended for use in operating activities,
- over a long period of time exceeding the reporting period,
- there is the probability of obtaining economic benefits from their use,
- the cost of the item is measurable reliably.
There are different types of capital expenditures CAPEX: some are aimed at the GROWTH of production capacities and company assets, others on their MAINTENANCE. The companies sometimes reflect such kind of cost allocation in their annual and quarterly reports. Maintenance CapEx refers to expenditures that are necessary to maintain the current business activity and keep the level of profit stable. Growth CapEx is company's spending on new assets that are intended to expand the company’s productive capacity. The difference between the two types of CAPEX is the following: growth capex is an investment, while maintenance capex is a cost. You can find an example of such separation of expenditures in an Excel template below.
What is OpEx? Operating expenditure
Operating expenses arise in the process of the current business of an enterprise and they represent day-to-day expenses. OPEX refers to the costs associated with financial, manufacturing, business operations and services. Unlike capital expenditures, operating expenses are fixed and regular one. Operating expenses directly affect business profitability: the higher the OPEX value, the lower the company's net profit. Unreasonable increase in operating expenses is always negatively perceived by investors, so, the company's management is trying to minimize them. However, it is very crucial that reducing OPEX should not compromise the quality of the product or service that company offers.
Most of the annual costs of a company are operating expenses. Examples of operating costs:
- business expenses,
- administrative expenses,
- management expenses,
- logistics costs,
- research and development costs (R&D).
With more detailed classification, this may include such expenses as rental, salary, raw materials, advertising, transport, insurance, taxes, utilities, specialist services (outsourcing), etc.
An indicator of a company's performance is the share of operating expenses relative to the company's revenue. The growth rate of OPEX should not be higher than the growth rate of revenue, otherwise it will be an indicator of a decrease in operating efficiency and, as a result, a reduction in profit. Each company strives to improve these indicators.
OPEX and CAPEX accounting
Capital expenditures are allocated over the useful life of a particular asset, often for several years; operating expenses are written off in the reporting year in which they are incurred. When carrying out accounting of CAPEX, costs are capitalized on the balance sheet of the enterprise, are listed under the property, plant, and equipment section. In the cash flow statement CAPEX is listed in the investments section. As a result of capitalization, there is an increase in the value of assets and net profit. It takes place because CAPEX costs are written off in subsequent reporting periods gradually in the form of depreciation. Depreciation allows the company to avoid a significant net profit decrease in the year the asset was purchased.
Since capital expenditures, as mentioned above, increase the value of assets, the funds in any case remain in the enterprise itself, while operating expenses are funds that take finally out of circulation and transfer to other companies - partners and intermediaries, i.e. they go outside of the enterprise. Thus, capital expenditures are purchases that will be used by company in the future.
OPEX are listed in company’s income statements. They are fully deducted from revenue in the accounting period they were incurred.
The startups that just started their business, as a rule, are more dependent on other companies, therefore, they will have more OPEX. Over time, it is worth to increase the assets, i.e. increase CAPEX in order to reduce this dependence and possible problems associated with it.
Example of accounting:
- the company have purchased equipment — this expense has to be attributed to capital costs, CAPEX;
- during the operation of the equipment, it is required to carry out maintenance and repair - in this case, the expense will be recorded to operating costs, OPEX;
- if the equipment is on a lease, it is an operating expense, and it will be attributed to OPEX.
Why is it necessary to separate the costs to capital CAPEX and operating OPEX?
From the point of view of a private entrepreneur, both groups of expenses are business-related costs. For the management of a large company, investor, or other interested parties, such a separation is necessary to obtain a clear picture of the company's spending directions. Studying the dynamics of operating expenses over a certain period, if there is sufficient data, it is possible to trace, for example, the reasons of significant changes in costs. It is not less important the fact that with the correct distribution of costs, it is possible to manage the profit and the amount of tax on this profit more competently. It is quite simple to explain this:
With an increase in operating costs OPEX, net profit decreases, and hence the amount of tax on it. An increase in capital expenditures CAPEX leads to a growth in the value of the company's assets and profit, and as a result, the amount of income tax increases as well.
Getting the higher net profit is usually more advantageous, for example, for shareholders awaiting dividend payments, or top managers receiving annual bonuses that are calculated based on net profit after tax. Although, it is also worth to mention, that typically the bonus payments are based on the key performance indicator (KPI) plan.
Using OPEX and CAPEX indicators, investors are able to evaluate the profitability of the company while deciding on the purchase of securities. Potential shareholders assess the CAPEX data and try to find such companies, which both pay out income and improve prospects for future profit by increasing capital expenditures.
By distinguishing between OPEX and CAPEX, there is a deeper notion about company’s expenses, that lead to more efficient firm’s financial control.
OPEX and CAPEX, free download template in Excel format
English, Russian and Finnish versions
| Name | File to download |
|---|---|
| OPEX and CAPEX | DOWNLOAD FREE |
| Операционные и капитальные затраты | СКАЧАТЬ БЕСПЛАТНО |
| Käyttökustannukset ja pääomakustannukset | LATAA ILMAISEKSI |