Last Updated on
July 12, 2023
By
Excedr
Capital expenditures, or CapEx, are a significant part of a business’s budget that involves spending money on long-term assets, also known as capital assets. These can include property, equipment, machinery, and buildings that are used to generate revenue over several years.
As a founder or member of the management team, you may already be familiar with CapEx. As a scientist or staff member, you might have heard management use the term before when discussing the purchase of new equipment or space.
In this blog post, we will define CapEx, explain its importance, and provide examples of capital expenditures in the life sciences industry.
Capital Expenditures (CapEx) represent the money that a company spends on long-term assets or investments. These assets are used to generate income or provide benefits for the company over several years or more. Capital expense is another term for CapEx.
CapEx is an expense capitalized on a company’s balance sheet as an asset rather than recognized as an expense on the income statement. This means that instead of immediately deducting from the company’s revenue, CapEx is recorded as an investment in the company’s long-term assets and is gradually depreciated over time.
Capital expenditures are essential for businesses to grow and maintain their competitive edge and can help a company improve its efficiency and productivity, which generally leads to increased profitability. Capital expenditures can include things like buildings, equipment, vehicles, and computer systems.
When a company invests in long-term physical assets such as property, plant, and equipment, it incurs an outlay or cash outflow for the cost of acquiring or improving those assets.
This outlay is usually recorded in the cash flow statement as a negative or cash outflow item, reflecting the fact that the company has spent money to acquire or improve its long-term assets.
Capital expenditures are not the same as operating expenses, or operating expenditures, which we’ll cover next.
Operating expenses (OpEx) and CapEx are two types of expenses that businesses incur. The main difference between them is that operating expenses are incurred through the day-to-day operations of a company, while capital expenditures are expenses that are incurred to acquire or improve long-term assets.
Operating expenses include expenses like rent, utilities, salaries and wages, advertising, and office supplies, which are generally recurring and typically have a short-term impact on a business’s financial statements. They are considered necessary expenses to keep the business running and generating revenue.
On the other hand, CapEx include physical assets like buildings, equipment, and land that are considered long-term investments. These expenses are typically large, one-time expenses that have a long-term impact on a business’s financial statements.
OpEx and CapEx are recorded on different financial statements. CapEx is recorded on the balance sheet—which shows a company’s financial position at a specific point in time—as an asset and is depreciated over its useful life.
In contrast, an operating expense is recorded on the income statement as part of the company’s operating costs and subtracted from its revenue to determine its operating income.
CapEx is meaningful for several reasons, the most important of which typically include growth and expansion, maintenance and replacement, and competitive advantage:
It can be pretty easy to see why a company’s CapEx budget is essential and why managing it is a critical part of not only staying in business, but growing and staying competitive as well.
Because capital expenditures can affect a company’s cash flow, profitability, and balance sheet, it’s a critical concept to understand since its effects on cash flow and profitability—and their subsequent recordings—will significantly impact a company’s financial performance and future prospects.
By managing CapEx effectively, founders and management can ensure they are investing in the right assets at the right time and in the right way. This requires careful planning, budgeting, and analysis to determine which investments will generate the highest returns and create the most value for shareholders.
It also requires understanding a company’s long-term goals, financial position, and competitive environment. By understanding CapEx and its importance to the company, founders and management can make informed decisions about allocating resources and investing in the company’s future.
For accounting and financial reporting purposes, a company’s CapEx for the current period is recorded on the cash flow statement and the balance sheet. The cash flow statement shows the cash inflows and outflows related to CapEx during the current period, while the balance sheet shows the net book value of the company's long-term assets after depreciation.
Analyzing a company's CapEx for the current period can provide valuable insights into its financial health, growth prospects, and investment strategy.
For example, a high level of CapEx spending in the current period may indicate that the company is investing heavily in new projects, expanding its operations, or upgrading its infrastructure. On the other hand, a low level of CapEx spending may suggest that the company is prioritizing short-term profitability over long-term growth.
There are several types of capital expenditures that a company can make, depending on its industry, size, and growth plans. Here are some common types of CapEx:
Property, plant and equipment include capital investments in buildings, land, machinery, vehicles, furniture, and other fixed assets that are necessary for a company’s operations. Examples include the construction of a new factory, purchasing new production equipment, or installing new computer systems.
This includes investments in software, hardware, and other technology assets necessary for a company's operations. Examples include investments in new software systems, upgrades to existing technology, or the development of new mobile applications.
This includes investments in acquiring other companies, businesses, or assets that are expected to generate future benefits for the company. Examples include purchasing a competitor's business or buying a new distribution center.
This includes investments in environmental and sustainability initiatives, such as renewable energy projects or waste reduction programs. These initiatives are becoming increasingly important as companies aim to reduce their carbon footprint and improve their environmental impact.
The life sciences industry involves developing and manufacturing drugs, medical devices, and biotechnology products. As such, capital expenditures in this industry typically include investments in research and development, laboratory equipment, and manufacturing facilities.
Here are some examples of capital expenditures in the life sciences industry:
Capital expenditures in R&D typically involve investments in equipment and facilities to develop new drugs and therapies. These expenditures are necessary to stay competitive in the industry and can be costly. For instance, pharmaceutical companies may invest millions of dollars in R&D to develop a new drug.
Capital expenditures in laboratory equipment involve investments in specialized equipment, such as mass spectrometers, chromatography equipment, and other analytical instruments used for research and testing. These investments can be significant, and businesses must ensure they have the necessary equipment to remain competitive.
This includes investments in patents, copyrights, trademarks, and other intangible assets that are expected to generate future benefits for the company. Examples include expenses related to developing new products, trademarks, or patents.
Capital expenditures in manufacturing facilities are essential to meet product demand and ensure they are produced to meet specific and required quality standards. These expenditures can involve investments in building new facilities or upgrading existing ones to increase production capacity.
Here are some examples of capital expenditures in other industries, including manufacturing, technology, and construction.
A manufacturing company might spend CapEx on new equipment that will help to increase production capacity. This could include things like new machinery or automation systems. By investing in this type of CapEx, the company can improve its output and generate more revenue over time.
A technology company might spend CapEx on research and development (R&D) of new products or technologies. This type of CapEx is considered growth CapEx, as it is intended to help the company grow its business and remain competitive in the marketplace.
A construction company might spend CapEx on new buildings or equipment that will help to improve its efficiency and productivity. This could include things like new cranes or trucks or new software systems that help to manage the construction process.
Before explaining the difference between maintenance CapEx and growth CapEx, it is important to distinguish it from two other types of expenditure on assets, working capital and repairs and maintenance.
If a company's primary business is buying and selling equipment, purchasing new equipment might initially be considered working capital (inventory) instead of CapEx. Similarly, if a company spends money on equipment that doesn’t provide lasting benefits, the expenditure would likely be classified as repairs & maintenance rather than CapEx.
CapEx does not go through a company’s Profit & Loss statement. Instead, the expenditure goes through the cash flow statement and is capitalized as an asset on the balance sheet, with wear and tear periodically recognized as a depreciation expense in the Profit & Loss section.
By contrast, the purchase of inventory for the purposes of resale and repairs and maintenance of capital equipment go through the company’s Profit & Loss, thus reducing earnings for the period.
These distinctions are essential for accounting purposes because they determine how the expenditures will be recognized on your financial statements. By properly categorizing expenses, companies can avoid misreporting financial data and ensure that their financial statements accurately reflect their financial position.
Let's consider an imaginary company, BullFrog Inc., that produces electronic gadgets, gizmos, and gear. In their recent financial report, the company disclosed that they spent $500,000 on purchasing new machinery during the current period. This expenditure would be classified as CapEx and not an expense.
On the company’s cash flow statement, the $500,000 would be shown as an outflow under the "Investing Activities" section, as it was used to acquire a long-term asset. This outflow reduces the company's cash balance, but the $500,000 does not directly impact BullFrog Inc.’s earnings or profit for the period.
However, on the balance sheet, the $500,000 spent on new machinery is capitalized as an asset, increasing BullFrog Inc.'s total assets by $500,000. This also increases the company's earnings for the period since the purchase is not immediately expensed as a deduction from revenues.
By recognizing the $500,000 expenditure as CapEx, BullFrog Inc. can improve its financial position, as it has invested in a long-term asset that is expected to generate future returns. Additionally, the company's earnings and assets for the period are increased, making it a preferred classification for companies that want to increase their profitability and strengthen their balance sheet.
Knowing how to define CapEx clearly is crucial if you want to understand the distinction between maintenance CapEx and growth CapEx. It will allow you to correctly categorize CapEx initially and then distinguish the type of CapEx the expenditure falls under.
Maintenance CapEx is money that a company spends on maintaining its existing assets. This includes things like repairing equipment, replacing parts, and upgrading systems.
Growth CapEx, on the other hand, is money that a company spends on new assets or investments to help the company grow its business. This includes building factories, purchasing equipment, or developing new products.
The distinction between the two categories can sometimes become indistinct. This is evident in industries like advertising, where continual brand promotion is critical for maintaining awareness and represents a maintenance capital expenditure while also shaping the preferences of new consumers, which is a growth capital expenditure.
Research and development (R&D) costs are another good example. Some R&D expenses are essential for sustaining a business, while others can be considered investments for future growth.
Nonetheless, the differentiation between maintenance and growth CapEx can be essential for understanding a business’s underlying cash flows when it is not expanding.
The CapEx formula is a simple calculation that can determine a company’s capital expenditures in a given period. The formula is as follows:
CapEx = PP&E (Property, Plant, & Equipment) + Capitalized Software - Depreciation & Amortization
In this formula, PP&E represents any purchases of property, plant, and equipment the company made during the period, while capitalized software refers to any software purchases capitalized as an asset. Depreciation and amortization refer to the reduction in the value of these assets over time, which is accounted for in the company’s financial statements.
For example, let’s say a fictional company called ABC Manufacturing has made the following purchases during the year:
To calculate the company's CapEx for the year, we would use the formula:
CapEx = $500,000 + $100,000 - $150,000 = $450,000
This means that ABC Manufacturing has spent $450,000 on capital expenditures during the year after considering the impact of depreciation and amortization on the value of its assets.
The CapEx formula is important for businesses because it helps them understand their capital spending needs and make informed decisions about allocating their resources.
By tracking their CapEx over time and comparing it to other financial metrics such as revenue and profitability, businesses can gain insights into their financial health and identify areas where they may need to invest more or less to achieve their strategic goals.
Managing a CapEx budget properly is essential for any business. Doing so can ensure you have enough funds to invest in long-term assets necessary for growth and expansion while maintaining financial stability. Here are some tips on how to manage your CapEx budget more effectively:
Plan carefully, make the right prioritizations, and continually monitor your expenses. Businesses should develop a multi-year plan and consider alternative financing options such as leasing to help manage their budget.
Capital expenditures are significant investments businesses make in long-term assets that generate revenue over several years. CapEx is an important concept in finance, and understanding capital expenditures is crucial because they can significantly impact your company's financial health. By investing in CapEx, companies can improve their efficiency, productivity, and competitiveness in the marketplace. General CapEx examples include new equipment, buildings, and research and development projects.
Capital expenditures in the life sciences industry involve investments in research and development, laboratory equipment, and manufacturing facilities. As a life science or biotech startup or SMB, it’s important that you make informed decisions about your capital expenditures to maintain a healthy cash flow and remain competitive in your industry.
Leasing is just one helpful approach for managing capital expenditures. It has several advantages that can help businesses optimize their CapEx budgets.
When you lease, you can take advantage of lower upfront costs, allowing your company to acquire long-term assets without paying for them entirely up front, freeing up cash flow and making it easier to manage your CapEx budgets.
Additionally, leasing typically involves fixed payments over the term of the lease, which can help you better plan and manage your cash flow, as you’ll know exactly how much you need to pay each month.
When you lease through our leasing program, we can also take on the responsibility for maintenance and repair costs, further reducing the burdens you would face purchasing the equipment outright or with a loan, saving money on upkeep expenses, and making it more cost-effective to manage your assets.
If you’re interested in leasing, let us know!
Since lab equipment can make up a large chunk of companies’ CapEx budget, we talk about CapEx a lot at Excedr. Here are some of the FAQs we get the most.
CapEx is money a company spends on long-term assets or investments while operating expenses are the day-to-day expenses that a company incurs to keep the business running.
Depreciation is the gradual decrease in the value of an asset over time. CapEx is the money that a company spends on acquiring or improving assets.
CapEx is important because it allows companies to invest in long-term assets that can improve their ability to generate income over time. Companies can increase their competitiveness and profitability in the marketplace by making strategic investments in CapEx.
CapEx can also help companies improve their efficiency and productivity, leading to cost savings and increased profitability.
Some common examples of CapEx include investments in new equipment, buildings, and infrastructure. CapEx can also include investments in research and development, which can help companies create new products and services that meet customers' changing needs.
Companies can finance CapEx through various means, including using their cash reserves, taking out loans, or issuing bonds or other types of debt. The method of financing CapEx will depend on a company’s financial situation, its creditworthiness, and the cost of capital.
