CapEx formula: how to calculate capital expenditures

What is the CapEx formula? (Quick answers)

The capital expenditure formula is super simple:

CapEx = ΔPP&E + Depreciation

where:

CapEx = capital expenditures

ΔPP&E = Change in PP&E (property, plant, and equipment), or:

ΔPP&E = Current period PP&E - the prior period PP&E.

Depreciation = any depreciation expense incurred over the period.

How to calculate capital expenditures ratio (CapEx ratio)

Here's the formula to calculate the CapEx ratio: 

CapEx ratio = Operating cash ÷ CapEx

A CapEx ratio > 1.0 means you have sufficient funds to spend on capital expenses.

If your number is under 1.0? Consider financing to extend our purchasing power to fuel growth. 

If you want to know more about calculating capital expenditures, keep reading.

What are capital expenditures (CapEx)? 

Capital expenditures (CapEx) are funds a company spends to acquire, maintain, and upgrade fixed assets like property, buildings, or equipment (PP&E).

Capital expenditure purchases are most often used to fuel development and growth for the company.  Examples include the construction of new facilities, maintenance, and expansion of existing facilities, and the purchase or upgrade of technology.

For example, new computers for a company's office are an item of capital expenditure. They're a considerable expense (often in the tens of thousands for just a few units) and the type of purchase that only occurs once every few years.

On the other hand, buying a few new office chairs wouldn’t be a capital expenditure. It’s a minor purchase that doesn’t affect long-term growth or produce an asset.

That said, a significant build-out of a new location might be considered CapEx since the project focuses on growing the business—and the office chairs could be rolled into that.

Another qualifying consideration is total cost.

Companies usually have a cap on expensing anything under $1,000. For instance, if something can be capitalized—if the total cost of that item is over $1,000—it will go on the balance sheet and then be expensed over the useful life.

So back to our office chairs—if you bought them in bulk and their cost surpassed your expensing threshold, they could be CapEx. But otherwise, you wouldn't capitalize them.

If that sounds a little arbitrary, it's because it is. What's important is maintaining consistency in how you decide what is and isn't CapEx.

How are a company's capital expenditures different from its operating expenses? 

Operating expenses are the things a business needs to spend money on to function.

A capital expense is money spent on a fixed asset like machinery or a building.

So yes, while the company needs machinery or a physical location to function, they're still considered CapEx because they're fixed assets.

Capital expenditures are also subject to accumulated depreciation—the loss in value those assets sustain with age.

Integrating real-time data for informed CapEx decisions

The traditional approach to CapEx planning often involves looking at historical data and trends, which, while useful, can leave companies playing catch-up with the market.

Real-time data can streamline compliance and reporting. With instant access to financial records and asset statuses, companies can ensure that their CapEx reporting aligns with regulatory requirements and accounting standards, avoiding potential discrepancies that could arise from outdated information.

Types of capital expenditures

Not every large-ticket purchase is a capital expenditure (although many are). CapEx purchases are differentiated by their role in furthering the company’s goals and expansion efforts. They are often (but not exclusively) physical assets with long lifespans. 

Common types of capital expenditures include: 

• Land and buildings
• Vehicles and heavy equipment
• Computer hardware and software
• Intangible assets like patents, copyrights, and intellectual property (IP)

 Some businesses treat certain upgrades and maintenance costs as capital expenses if they significantly increase the value or lifespan of an asset.

What are fixed assets?

Fixed assets are long-term tangible properties (like buildings) or equipment (like machinery) that a company owns and uses to make a profit.

Fixed assets are fixed because the company isn't expected to sell them (or use them to the point of exhaustion) within a year of their purchase. So they're fixed.

On the balance sheet, these are often recorded as PP&E (property, plant, and equipment).

How does a capital expenditure appear on the three financial statements? 

Capital expenditures costs appear in different sections on a company’s cash flow statement, balance sheet, and income statement. The spending on purchases appears as a liability, while the resulting physical assets appear on the three financial statements as an asset.

In more detail, CapEx appears on each financial statement as follows:  

• On the balance sheet, capital expenditures are recorded in the "property, plant and equipment (PPE) line item, which represents long-term assets such as buildings, vehicles or machinery. It is listed in the long-term section of the balance sheet and depreciates over time.
• The income statement reports capital expenditures under long-term investments or non-operating expenses. They are subtracted from total revenues to calculate net income for the period.
• On the cash flow statement, capital expenditures are reported under investing activities. They show up as an outflow from a company’s operating activities. They can measure how much money was spent to acquire new assets during the prior reporting period.

Applying the CapEx formula to practical business situations

Let’s take a look how the CapEx formula is applied in real-world business cases, driving financial strategy and operations.

New Equipment Acquisition: A manufacturing company wants to purchase new machinery to increase production capacity. The CapEx formula helps the company calculate the total capital expenditure for the year by adding the cost of the new machinery (change in PP&E) plus any depreciation on existing equipment.

Technology Upgrades: An IT firm is looking to upgrade its servers and cybersecurity systems. The firm uses the CapEx formula to determine the investment required by adding the cost of the new servers to the depreciation expense of the old servers to maintain an up-to-date technology infrastructure.

Facility Expansion: A growing logistics company requires more warehouse space. By using the CapEx formula, the company can determine the investment needed for the expansion by adding the construction costs to the depreciation of their current facilities.

Fleet Enhancement for a Transport Business: A transport company decides to expand its fleet of delivery vehicles. The CapEx formula will aid in calculating the capital spent on new vehicles and adding the depreciation costs of the existing fleet for that financial year.

Investment in Renewable Energy Resources: An energy company plans to invest in solar panels to reduce operational costs and carbon footprint. The CapEx formula will help estimate the capital spent by adding the purchase and installation costs of the solar panels to the depreciation of any existing energy-generating assets.

Innovations in the CapEx Formula

Businesses are now at the cusp of a new era where advanced technologies and innovative methodologies are streamlining and refining the CapEx process. Let’s explore how modern tools and techniques are enhancing the traditional CapEx formula for better accuracy.

Integration of Big Data: Modern businesses harness big data to feed into the CapEx formula, allowing for more nuanced financial forecasting. By analyzing large datasets, companies can identify patterns and predict future capital needs with greater precision. This data-driven approach can significantly reduce the risk of over or under-investing in capital projects.

Enhanced Reporting Capabilities: Innovations in reporting tools mean that the insights derived from the CapEx formula are more accessible and understandable to stakeholders. Real-time dashboards and interactive reports help managers make timely decisions about capital allocation. Enhanced visualization of CapEx spending trends and forecasts empowers better strategic planning and reporting to investors.

Collaborative Financial Planning: The evolution of cloud computing has facilitated collaborative environments where cross-departmental input into the CapEx formula is possible. Teams across different functions can contribute data and insights, leading to a more holistic view of CapEx needs. Such collaboration ensures that capital expenditure is aligned with the company’s overall strategy and operational requirements, enhancing the effectiveness of investments.

From the integration of sophisticated software to the adoption of cutting-edge analytical techniques, these advancements are not just enhancing accuracy—they're fundamentally transforming how companies plan, predict, and invest in their futures.

How does CapEx relate to cash flow? 

Capital expenditures involve spending money to purchase assets with the expectation that these assets will increase the growth or prosperity of the company. 

As explained previously, because CapEx is a non-cash expense, it does not directly affect cash flow, but the indirect effect is still important to consider as it can lead to a decrease in cash on the balance sheet.

When considering CapEx for accounting purposes, looking at the initial cost of purchasing an asset and any associated costs, such as taxes or interest, associated with taking out a loan is important. Additionally, it's important to consider depreciation and amortization when factoring in CapEx expenses into the overall cash flow. 

By properly tracking capital expenses and their associated costs over time, companies ensure they make sound financial decisions when investing in assets.

How does depreciating an asset improve cash flow numbers? 

While companies can’t automatically write off the cost of expenses to free up cash, reducing taxes through depreciation leaves more money in the bank for other purposes.

FP&A can report better cash flow numbers offset by tax reductions by recording regular depreciation intervals.

This gives companies more money to invest in operations and other income-generating activities instead of spending that money on taxes. Additionally, this helps control debt levels as the company can spread out payments over a long period of time.

How are capital expenditures used in calculating free cash flow-to-equity (FCFE)?

Capital expenditures are also used in calculating free cash flow to equity (FCFE). FCFE is the amount of cash available to equity shareholders.

The most common way to calculate FCFE is:

FCFE = EPS − (CapEx − Depreciation) × (1 − DR − ΔC × (1 − DR))

where:

FCFE = Free cash flow-to-equity

EPS = Earnings per share

DR = Debt ratio

ΔC = ΔNet capital or change in net working capital​​

What considerations should I make for capital expenditures?

When making a capital expenditure it’s important to look at the expense in the larger context of your financial position.

Think about the total cost of the purchase (including taxes and interest payments), depreciation and amortization schedule, availability of funds for the purchase, and whether or not it aligns well with the company’s long-term goals. 

Some factors to consider when you’re considering or budgeting for a capital purchase: 

They’re a commitment

Capital expenditures are big-ticket items.

They often fulfill a specific need of your individual business. While they offer huge benefits to your growth potential, their value doesn’t always translate to other businesses.

For this reason, resale prices on many capital assets are much lower than your original investment. When considering a large capital investment, be sure there’s a long-term business case to support it.

They decline in value over time

While it’s true that capital expenditure purchases carry tax benefits, these are existing fixed assets that will lose value over time.

Your asset value will decline as you use these purchases within your business.

Again, be sure the investment is worth the long-term upside.

They may strain cash flow

Large capital asset purchases can be a big drain on your cash flow.

Ensure you have the necessary funds to cover the upfront cost of any major acquisition.

Also, build these purchases into your long-term budget so you don’t experience any surprises. 

They aren’t always scalable

Capital expenditures should give you long-term value for the investment. That said, these purchases should be able to keep up with your businesses as you scale. 

All these factors should be carefully weighed to ensure an organization effectively uses its capital expenditure budget.

Look at the long-term prospects of your purchase. Will a piece of equipment you purchase this year be able to keep up with production demands a few years later? If not, consider your future ability to recover value on the purchase. 

What impact do capital expenditures have on taxes?

When it comes to expenses, companies must be careful how they present expenses on the books and pay taxes on those assets.  

First, how does depreciation work?

Depreciation is an accounting technique that spreads the capital expenditure cost over its expected useful life.

In basic terms, it’s a way for businesses and organizations to account for the wear and tear on their equipment and property over time and decrease their taxable income by recognizing a portion of the cost of a specific asset as an expense each year. 

For example, if a business owner purchased a new company vehicle for $50,000, depreciation would help them spread out the tax impact of the purchase.

Assume the truck has an expected useful life of 10 years. In normal depreciation, the company could depreciate the purchase at $5,000 annually over those 10 years. 

This means that each year, the company could use the $5,000 depreciation as an expense on their taxes and reduce their taxable income by that amount.

This helps companies spread out the cost of large expenditures over a long period and avoid taking on too much debt when making these purchases.

Conclusion: Make your capital expenditures planning faster and easier

Now you know all about the CapEx formula.

You know how to calculate capital expenditures, locate and read off the correct items from the income statement and balance sheet, and even calculate the CapEx ratio.

Want to track your CapEx activity in Excel? Cube transforms Excel into a powerhouse with its pioneering Excel-native FP&A platform, simplifying your financial workflows.

Check out our free Capital Expenditures template and make sure to click the banner below to book a personalized demo to see Cube in action.