Which of the following are considered capital expenditures CapEx in Azure?

There are a variety of costs and expenses which companies have to pay in order to continue running their businesses. These costs can be one-off or they can be recurring, and it can often be challenging to keep up with all of these expenses. But how are they able to keep track of all of them?

One way is to divide them up into different categories—the most common of which are capital expenditures (CapEx) and operating expenses (OpEx). Capital expenditures are major purchases that a company makes, which are used over the long term. Operating expenses, on the other hand, are the day-to-day expenses that a company incurs to keep its business running.

Key Takeaways

• Capital expenditures are a company’s major, long-term expenses while operating expenses are a company’s day-to-day expenses.
• Examples of CapEx include physical assets, such as buildings, equipment, machinery, and vehicles. 
• Examples of OpEx include employee salaries, rent, utilities, and property taxes.
• Items covered by OpEx often have a useful life of one year or less, while CapEx tends to pay for a benefit to the company for longer than one year.
• Capital expenditures cannot be deducted from income for tax purposes, but operating expenses are eligible.

Understanding CapEx vs. OpEx

Businesses have a variety of expenses, from the rent they pay for their factories or offices to the cost of raw materials for their products, from the wages they pay their workers to the overall costs of growing their business. To simplify all of these costs, businesses organize them under different categories.

The two most common categories are CapEx and OpEx. The difference between these two expenditures lies primarily in the accounting treatment of each. For business in the United States, generally accepted accounting principles (GAAP) often dictate how an expenditure is treated on a company’s financial statements. Therefore, a company must understand the long-term financial implications of how its reporting will be affected and how external parties may view the company’s health as a result.

There is an inherent difference in the way management may approach these two expenditures as well. CapEx is often more expensive and labor-intensive and often requires greater patience to reap rewards. OpEx is often cheaper and more flexible to incur. For many reasons, it is important to understand each type of expenditure and how a company may strategically approach either.

Capital Expenditures (CapEx)

Capital expenditures (CapEx) are purchases of significant goods or services that will be used to improve a company’s performance in the future. They include the cost of fixed assets and the acquisition of intangible assets such as patents and other forms of technology. Capital expenditures are typically for fixed assets like property, plant, and equipment (PP&E). For example, if an oil company buys a new drilling rig, the transaction would be a capital expenditure.

One of the defining features of capital expenditures is longevity, meaning that the purchases benefit the company for longer than one tax year.

CapEx represents the company’s spending on physical assets. The following are common examples of capital expenditures:

• Manufacturing plants, equipment, and machinery
• Building improvements
• Computers
• Vehicles and trucks

Each industry might have different types of capital expenditures. The purchased item might be for the expansion of the business, updating older equipment, or expanding the useful life of an existing fixed asset. Capital expenditures are listed on the balance sheet under the PP&E section. CapEx is also listed in the investing activities section of the cash flow statement. 

Fixed assets are depreciated over time to spread out the cost of the asset over its useful life. Depreciation is helpful for capital expenditures because it allows the company to avoid a significant hit to its bottom line in the year when the asset was purchased.

CapEx can be externally financed, which is usually done through collateral or debt financing. Companies issue bonds or take out loans to fund their capital expenditures or they can use other debt instruments to increase their capital investment. Shareholders who receive dividend payments pay close attention to CapEx numbers, looking for a company that pays out income while continuing to improve prospects for future profit.

Operating Expenses (OpEx)

Operating expenses are the costs that a company incurs for running its day-to-day operations. As such, they don't apply to any costs related to the production of goods and services. These expenses must be ordinary and customary costs for the industry in which the company operates. Companies report OpEx on their income statements and can deduct OpEx from their taxes for the year when the expenses were incurred.

The following are common examples of operating expenses:

• Rent and utilities
• Wages and salaries
• Accounting and legal fees
• Overhead costs such as selling, general, and administrative expenses (SG&A)
• Property taxes
• Business travel
• Interest paid on debt
• Research and development (R&D) expenses 

Operating expenses are incurred through normal business operations. The goal of any company is to maximize output relative to OpEx. In this way, OpEx represents a core measurement of a company’s efficiency over time.

Accounting rules may dictate whether an item is classified as CapEx or OpEx. For example, if a company chooses to lease a piece of equipment instead of purchasing it as a capital expenditure, the lease cost would likely be classified as an operating expense. If a company purchased the equipment instead, it would likely capitalize it.

CapEx vs. OpEx

If a company makes a purchase, that purchase must be classified as a capital or operating expenditure. Sometimes this matters, while at other times, it may not. Here are the similarities and differences between the two.

Key Similarities

Both capital expenditures and operating expenses represent outlays by the company. Both are usually acquired in exchange for cash and may go through a similar purchasing process. This includes solicitation of a bid, contracting, legal review, orchestration of financial payment, and receipt of the purchase.

Both CapEx and OpEx reduce a company’s net income, though they do so in different ways. OpEx is expensed immediately, while CapEx is depreciated.

Companies can also plan for both types of expenses similarly. Though they may be tracked separately internally, each type of cost may have its own budget, forecast, long-term plan, and financial manager to oversee the planning and reporting of each.

Key Differences

Capital expenditures are major purchases that will be used beyond the current accounting period in which they’re purchased. Operating expenses represent the day-to-day expenses designed to keep a company running. Because of their different attributes, each is handled in a distinct manner.

OpEx are short-term expenses and are typically used up in the accounting period in which they were purchased. This means OpEx is more often paid for in the period when it is acquired. CapEx may also be paid for in the period when it is acquired, but it may also be incurred over a period of time if the CapEx is related to a development project. For example, the building of a new warehouse may result in 1,000 transactions over a six-month period, all of which are collectively considered CapEx.

CapEx and OpEx are reported differently, as CapEx resides on the balance sheet and OpEx resides on the income statement. This is due to the difference in their accounting treatment. In addition, the method of translating the expenditure as an expense is different. CapEx is often associated with depreciation and accumulated depreciation accounts, while OpEx is not.

CapEx vs. OpEx

CapEx

• Holds long-term value or future benefit for the company

• Reported as an asset

• Reported on the balance sheet

• Recognized as an asset through depreciation over its useful life

• Usually higher dollar amounts

OpEx

• Holds short-term value and little to no future benefit for the company

• Reported as an expense

• Reported on the income statement

• Expensed immediately and not depreciated over any useful life

• Usually smaller dollar amounts

What Is the Difference Between Capital and Operating Expenditures?

Capital expenditures, also known as CapEx, are costs that often yield long-term benefits to a company. CapEx assets often have a useful life of more than one year. Operating expenses (or OpEx) are costs that often have a much shorter-term benefit. OpEx is usually classified as costs that will yield benefits to a company within the next 12 months but do not extend beyond that.

Which Is Better: CapEx or OpEx?

One type of expense is not better than the other. Rather, they are simply different ways to classify costs. If a company is trying to invest in its future and wants to be most efficient with its long-term capital, it might be better for it to invest in CapEx rather than OpEx. Alternatively, if a company wants to preserve capital and maintain flexibility, it might be better off incurring OpEx instead.

What Is an Example of OpEx?

Examples of operating expenses include repairs, salaries, supplies, and rent. All of these expenses benefit the company in the short term. For example, when rent is paid on a warehouse or office, the company using the space gets the benefit of the space for a given period (i.e., one month). Because the benefit received is short, the cost is OpEx.

What Is an Example of CapEx?

Examples of capital expenditures include development of buildings, vehicles, land, or machinery expected to be used for more than one year. In these instances, all of these assets will be used long-term. When acquired, they are treated as CapEx to recognize the benefit of each over multiple reporting periods.

How Are CapEx and OpEx Reported?

CapEx is reported on the balance sheet as a capitalized asset. Most CapEx assets are depreciated over their useful life; in this manner, an expense related to the asset is recognized each year evenly over its useful life. Some CapEx, such as land, is not capitalized.

OpEx, on the other hand, is reported on the income statement and is expensed immediately. Because there is no long-term value to OpEx, it must be expensed in the period in which it is incurred. OpEx is not depreciated over its useful life, and the entire expense is recognized right away.

The Bottom Line

CapEx and OpEx represent the types of costs that a company can incur. If there’s short-term value to the cost, it’s usually treated as OpEx. If there’s long-term value, it’s usually CapEx. Each type of cost is reported differently, strategically approached differently by management, and has varying degrees of financial implications for a company.

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