What is capital expenditure?

Running a business involves spending money. Much of that money is invested in making your business more efficient, improving its capacity, or building more value into its brand. This is the nature of capital expenditure (CAPEX), and it needs to be properly factored into your business accounting.

There can be some confusion regarding capital expenditure and how it needs to be recorded on the company balance sheet. Many assume that all their operating expenditure falls under capital expenditure. However, capital expenditure is not the same as typical operating expenditure, and the IRS treats deductions for these expenses very differently.

Capital expenditures encompass any spending that your company takes on to improve or enhance its operations. If it improves your business or helps to facilitate growth, it likely falls under the definition of capital expenditure. Typical operating expenditure tends to include rent, payroll, travel, maintenance and repairs, taxes, office supplies, depreciation and advertising.

Examples of capital expenditure

The IRS has specific guidelines on what is not classed as CAPEX. Capital expenditures (or capital investments) are generally high-cost or high-value items that will be with your business for the long haul or at least more than one accounting finance period. These commonly include:

Machinery and hardware

Upgrading or replacing your hardware can improve output and boost your company’s capabilities. They can improve operational efficiency, enhance production, or replace inefficient processes. As such, they are classed as capital expenditures.

Computers and software

Upgrading your digital infrastructure is essential when upscaling your business operations. Replacing hardware such as desktop computers and tablets, migrating to cloud or hybrid systems, and upgrading your SaaS solutions qualify as capital expenditures.

Upgrades to existing assets

Maintenance and repair costs are classed as revenue or typical operating expenditures. However, upgrades or improvements to existing assets are classed as capital investments because they contribute to the advancement of the business.

As we can see, capital expenses are multifaceted and can help improve your business in many ways. This is why it’s crucial to ensure that your cash flow allows for a capital expenditure budget.

Find out how Square can improve cash flow and facilitate capital expenditure.

Is capital expenditure the same as operating expenditure?

Both capital and operating expenditure contribute to the running of your business. However, current expenses are fundamentally different. Rather than improving or enhancing the business, they simply help to facilitate day-to-day operations.

Operating expenditure may include anything that goes into your Cost of Goods Sold, such as:

• employee wages
• inventory/stock
• rent or mortgage payments
• business travel costs
• employee catering expenses
• office supplies
• vehicle fuel and maintenance costs
• utilities

It is important to carry out regular cash flow analysis to ensure that the company has sufficient funds for both capital expenditure and current operating expenses.

Find out more about cash flow analysis.

Frequently asked questions about capital expenditure

How do I create a capital expenditure budget?

A capital expenditure budget should certainly be earmarked in your business finances.

These expenses are harder to track or predict than general operating expenses, and they need to be carefully considered so that they don’t disrupt business cash flow. When budgeting for capital expenses, consider:

• rate of return on your capital investments
• how long it will take to see some return on investment (ROI)
• any regulatory and legal requirements
• the opportunity cost of not making the purchase
• any bottlenecking that a purchase may cause for cash flow

What’s the difference between capital expenditure and current expenses

Capital expenditures are fixed long-term costs that contribute towards the improvement of your business operations.

Current expenses are the short-term costs involved in maintaining operations and keeping your business functional.

Are capital expenditures tax deductible?

Unlike current expenses, the IRS doesn’t allow capital expenditures to be deducted from your business profits in the same year. Instead, they are gradually deducted from your profits over several years. This process is called depreciation for physical assets and amortization for intangible assets

If your company buys a new machine for $9,000, at a depreciation rate of 36 months, the company effectively “loses” $250 per month due to the depreciating value of the machine. The company can deduct $3,000 per year for the machine’s depreciation.