What is meant by Capital Expenditure?
Capital expenditure refers to the funds used by a company to upgrade and maintain fixed assets as well as the money expended on undertaking new projects and investments. Capital expenditure is the money spent on acquiring fixed assets like new equipment, machinery, land, plant etc. and intangible assets such as patents or licenses, upgrading an existing asset, repairing an asset or repayment of loan. It is recorded on the balance sheet instead of the income statement as it is more of an investment that will derive returns in the long term than an expenditure.
What is the Purpose of Capital Expenditure?
Capital expenditures lead to the creation of assets in the long term. Capital expenditures are made by companies to increase the scope of operations of the company. It is also undertaken to add economic benefit to the operations. Features of Capital Expenditure The current decisions on capital expenditure will influence the future activities of the company – it provides direction to the company’s activity. It is an irreversible expenditure. These expenses are expensive, especially in industries such as production, manufacturing, telecom, utilities, and oil exploration. The capital invested undergo depreciation over a period of time. The accounting process related to capital expenditure is complicated.
Uses of Capital Expenditure
Capital expenditure can be used to derive a lot of important information regarding the company. For instance, the cash flow to capital expenditures ratio can be used to determine the company’s ability to acquire long term assets using free cash flow. It will show the fluctuations that the business will undergo through cycles of large and small expenditures. A ration that is greater than 1 implies that there is sufficient money to fund asset acquisitions. It is also used in calculation of free cash flow to equity (FCFE) which is the amount of cash that will be made available for distribution to the equity shareholders. A lower FCFE is a product of higher capital expenditure of the firm.
What is the Difference Between Capital Expenditure and Operating Expenditure?
Operating expenses are the costs incurred by the company in order to meet the day-to-day expenses of the company. It is a short-term expense that can be fully deducted from the company’s taxes in the year that the expense is incurred. Capital expenditure on the other hand, is an expense that has a life greater than one year and improves the useful life of an asset. Also, capital expenditures are not tax deductible, but can be deducted indirectly by way of the depreciation they generate.
