What is CapEX?
Capital expenditure – what is it and why do we have it?
One of the key things that business owners struggle to understand when it comes to company finance and accounting is capital expenditure or CapEX.
Capital expenditure is money that you’ve spent to purchase fixed assets – also called non-current assets or capital items (check out our guide to financial terminology) . Fixed assets are tangible items that you buy and pay for, but offer value to your business longer-term, such as:
With these, although the physical cash leaves your account at the point of purchase/invoice terms, because you’ll continue to get value from them, you show and spread the cost over a number of years.
So in the purchasing year you’ll have an actual expense of the initial amount, but you show the cost in your accounts as a percentage of the total for a set amount over the years, with the entire value being accounted for when that time period has elapsed,
The reason we treat fixed assets separately is nothing to do with market value, but with matching cost and revenue...
Treating fixed assets according to the matching/accruals principle
The matching principle means that the way you spread the cost of your fixed assets is via a process called depreciation.
Ask yourself: ‘What’s a fair proportion of the cost of the asset, applied to the profit generated by the business?”
Depreciation – not market value
Effectively, depreciation is like a usage charge and essentially a best guess of how long it will be used by your business to generate revenue. It allows you to spread the cost over the lifetime of its service in a fair and consistent way.
Consistency is key here and must be followed, as it prevents businesses from manipulating performance for the year just by changing their depreciation policy – but what those policies are in the first place is ultimately the subjective choice of the business, and although convention exists there are no hard and fast rules to what policies you set.
After purchasing a fixed asset, you may make decisions along the way such as selling it before it’s fully depreciated – but that just triggers a different outcome.