A Simple Guide to Understand CapEx, OpEx and Their Usage

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If you want to run a successful business, there are financial terms you should familiarize yourself. I have covered some of them in my previous articles and I would like to briefly explain CapEx (Capital Expenditure) OpEx (Operational Expenditure). Both of them are basic categories of expenses, but they differ in the nature of the expenses and in respective treatment for tax purposes.


CapEx


Capital expenditures are the amounts that companies use to purchase major physical goods or services that will be used for more than one year. The asset purchased may be a new asset or something that improves the productive life of a previously purchased asset. This might be buying a brand-new furniture, fixture, equipment, plant or a physical building.


CapEx is an expenditure that creates an avenue for revenue generation and value creation

Capital expenditures might include:

  • Purchase of fixed assets.

  • Plant, vehicles and equipment purchase or replacements

  • Restoration of an asset’s value by modernisation and technology upgrades

  • Building capacity expansion and improvements

  • Adapting machinery to a different use

  • Statutory, regulatory and welfare related activities

Capital expenditures are not fully deducted in the accounting period they were incurred. In other words, they are not fully subtracted from the revenue when computing the profits or losses a business has made.


However, intangible assets are amortized over their lifespan while the tangible ones are depreciated over their life cycle. The capital expenditure is recorded as an asset on the balance sheet under the section "property, plant & equipment." However, it's also recorded on the cash flow statement under "investing activities," since it's a cash outlay for that accounting period. Once the asset is being used, it's depreciated over time to spread the cost of the asset over its useful life. In other words: Each year, a part of the fixed asset is being used up. Depreciation represents the amount of wear and tear on the fixed asset, and the amount of depreciation for each year can be used as a tax deduction.


In general, capital expenses are most often depreciated over a five to 10-year period but may be depreciated over more than two decades in the case of real estate. This is an upfront investment with full payment and profit capitalisation is slow and gradual.


OPEX:


Operational expenditure consists of those expenses that a business incurs to run smoothly every single day. They are the costs that a business incurs while in the process of turning its inventory into an end product. Hence, depreciation of fixed assets that are used in the production process is considered OpEx expenditure. OpEx is also known as an operating expenditure, revenue expenditure or an operating expense.


OpEx is in simple, terms, an expenditure incurred to operate the business or systems

Operating expenses are fully deducted in the accounting period they were incurred. As operational expenses make up the bulk of a company's regular costs, management typically looks for ways to reduce operating expenses without causing a critical drop in quality or production output. In contrast to capital expenditures, operating expenses are fully tax-deductible in the year they are made.


In this respect, all expenses incurred to operate the business and systems falls under OpEx. This includes employee wages, repair and maintenance of equipment, rental fees, and utility bills and so on;

  • License fees

  • Advertising and subscription costs

  • Legal and attorney fees

  • Utility costs e.g. energy, water

  • Insurance fees

  • Property management costs