The assets your organization chooses to invest its financial capital in can mean the difference between organizational success and failure. These investments — also known as capital expenditures — involve complex considerations involving budgeting, your organization’s project portfolio and industry-specific concerns. This complexity ensures that answering the question of where to make a capital expenditure is rarely easy. Should an oil and gas company open a new refinery or renovate an existing site? What about a construction firm evaluating which new piece of equipment will help them complete their next project most efficiently?
To make every dollar your company puts towards capital expenditures go as far as it can, organizations must effectively account for these variables by leveraging robust capital budgeting and planning software. They must also have a solid understanding of how to calculate capital expenditures. Let’s take a close look at these and other key factors behind making intelligent capital expenditure decisions.
What are capital expenditures?
Capital expenditures (CapEx) are investments used to maintain, purchase or upgrade many kinds of non-consumable assets. These assets typically have high up-front costs, but they often represent the means by which an organization generates revenue or supports its internal infrastructure. CapEx funds may be used to replace an outdated vehicle or piece of machinery, upgrade an organization’s computers, repave a parking lot or pay for the construction of a new facility. While traditionally CapEx funds were only used to purchase physical assets, investments in IT infrastructure and other technologies are now also classified as capital expenditures. Physical assets acquired with capital expenditures typically depreciate over their service lives.
Capital expenditures are generally made to enable new projects or facilitate current operations. They represent long-term investments that have the potential to impact your company for weeks, months or even years afterwards. To ensure that the significant costs associated with capital expenditures don’t go to waste, organizations should take all the steps needed to maximize the chances of success for associated capital projects.
This starts with adopting an enterprise capital budgeting and planning solution. These platforms help navigate many of the hurdles associated with making effective expenditures. By integrating all project processes and data in a single place, the best solutions enable companies to align their capital expenditures with their project portfolio, available capital budget and overall business objectives. This allows companies to ensure these expensive, critical initiatives are actually moving them closer to their own vision of success. These platforms also let organizations more accurately evaluate potential CapEx scenarios and make changes to current investments to boost capital efficiency.
For more insights on CapEx and how businesses allocate their resources, explore the Annual Capital Expenditures Survey (ACES). ACES is conducted by the U.S. Census Bureau and gives an overview of the capital expenditures made by non-farm businesses operating within the United States. The report can help your company better understand the CapEx investment landscape, as well as industry-specific trends, to guide its own CapEx spending decisions.
CapEx vs. OpEx
Capital expenditures are one-off investments in the future of your business, rather than recurring costs. This means they are recorded as assets on your company’s balance sheet, rather than as expenses, and cannot be immediately written off to reduce a company’s revenue like other business expenses. Capital expenditures are distinct from more common costs called operating expenses (OpEx). These are recurring payments that can be deducted from your income statement. They include utility costs, fuel, wages, accounting fees, taxes and interest paid on debt.
Due to their more frequent nature, OpEx decisions can often be made unilaterally by leaders at lower levels of an organization. In contrast, capital expenditures usually involve larger sums and play a key role in determining the overarching business strategy of an organization. This means that they must typically be made or approved at a company’s highest levels of leadership.
Types of capital expenditures
There are many types of capital expenditures, each serving a distinct purpose and involving unique considerations. Here are some of the most common:
- Buildings. New structures can be used to manufacture products, store inventory, provide a workspace to employees and more.
- Land. Typically, only land purchased for development is classified as a capital expenditure. If your business purchases land for speculative purposes, this expense may be categorized separately on your expense sheet.
- Computers. Computers and other devices support critical aspects of business operations, including reporting, communication, collaboration and managing logistics.
- Equipment. This category includes any machinery used for manufacturing, sorting, mining, or otherwise delivering products to buyers.
- Vehicles. This type of CapEx includes vehicles used for any business purpose, like picking up customers or transporting goods.
- Furniture. All desks, chairs and other office furniture are classified as capital expenditures.
- Patents. Although patents are not tangible assets, they represent a long-term investment produced by significant, and often costly, research and development efforts, which is why they’re considered capital expenditures.
Alternatively, organizations can classify various types of capital expenditures together according to their purpose:
- Acquisition expenses. Capital expenditures are often used to acquire new assets, including machinery, buildings and vehicles.
- Upgrade costs. Money allocated to upgrading existing assets also falls under the heading of CapEx.
- Renovations. Renovating existing assets is a common CapEx investment and can be less expensive than buying an entirely new asset. This involves making payments to update and improve an asset, rather than costs spent to fix it after it breaks down.
- Repairs. Of course, capital expenditures are also frequently used to repair assets when their function is impaired. This category doesn’t include routine maintenance, like replacing tires on a fleet vehicle or performing regular oil changes, which instead counts as operating expenses.
- Adapting assets. CapEx funds can also be used to adapt an existing asset for an entirely new purpose. Retrofitting assets can be another effective way of minimizing costs while ensuring that your company’s needs are met.
Launching a new business. Starting a new business venture or acquiring an existing company is likely one of the largest — and most important — capital expenditures an organization will ever make, with great potential risks and rewards.
How to calculate capital expenditures
The formula used to calculate net capital expenditures is relatively straightforward:
ΔPP&E + current depreciation of assets = CapEx.
In this formula, “ΔPP&E” represents the change in property, plant and equipment – an aggregate reported value. To determine the change, subtract the prior period value from the current period . This formula is most useful for determining CapEx as an outsider from public financial statements. Within your own organization, you would already have the amount you spent yearly on capital expenditures broken out in the budget. You would be more concerned with questions like how to finance and get the most value out of the expenditures going forward.
Capital expenditures are used in other calculations as well. These include those used to determine how much cash your organization has available for any equity shareholders and ratios used for analyzing organization financial health.
Why use CapEx planning and budgeting software?
Managing capital budgets and expenditures is a multi-year process that’s often complex and challenging. Long-term business success demands a strategy for effectively managing your capital expenditures and organizational budget to ensure that your expenditures align with your company’s immediate and future goals.
Implementing a robust capital planning and budgeting solution is the best way to maximize the value of your capital expenditures. Look for a platform that lets you build and manage annual capital spending plans, generate accurate forecasts for monthly spending plans and better communicate the benefits of proposed capital expenditures to company leadership and external stakeholders alike. The best capital planning and budgeting solutions also include comprehensive reporting tools, so organizations can establish performance baselines and capture progress snapshots to more effectively evaluate how well their capital plans are performing in the wild.
Ensure your platform integrates capital-related capabilities with features used to manage every level of a project portfolio as well. These include functions for portfolio planning and control, resource management and issue, change and risk management. With the ability to leverage connected data from across your company, you can achieve an unmatched level of strategic alignment, striking an ideal balance between short- and long-term goals, your annual budget and your other available resources.
Organizations in the industrial space can also leverage asset investment planning (AIP) to optimize their capital plans. AIP leverages asset information from across enterprise asset management systems to predict how those assets will perform. Choosing a CapEx platform that includes AIP functionality helps your organization increase visibility into future asset needs, maximize resources used for asset maintenance and replacement and more effectively plan the projects that will maximize asset performance.
Make better-informed CapEx decisions with EcoSys™
Your organization’s capital expenditure budget should be strategically invested to prioritize valuable projects that complement the rest of your company’s portfolio, supporting long-term growth. With a dynamic capital budgeting and planning solution like EcoSys, you can confidently make CapEx investment decisions. EcoSys is an enterprise project performance (EPP) platform, combining the ability to implement best practices for capital budgeting and planning, no matter what your organization’s current processes are, with features for effectively managing individual projects and your company’s entire portfolio once capital expenditures are made.
If you’re ready to rethink the way you manage capital expenditures and projects, contact Hexagon today.