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An organization's or a business entity's capital expenditures (CapEx) are the funds used to purchase, enhance, or prolong the lifespan of fixed assets like homes, cars, equipment, or land. Fixed assets are long-term investments that are capitalized or documented on the company's balance sheet and have a useful life of at least one year.
Organizations need CapEx to maintain their current assets and machinery, as well as to invest in new technology and other initiatives that can improve their competitiveness, productivity, and efficiency. Decisions about capital expenditures (CapEx) are frequently strategic and dangerous for the company because of their long-term impacts, high initial costs, and irreversibility.
Acquisition expenses and expansion expenses are the two primary subcategories of CapEx. Spending on acquisitions includes buying existing fixed assets from another organization, such as purchasing a factory, a plant, or a business. Expansion expenditures are the funds used to upgrade existing fixed assets, such as buildings, with new equipment to boost their capacity or efficiency.
CapEx can be calculated by using the following formula:
CapEx = Net fixed assets at the end of the period - Net fixed assets at the beginning of the period + Depreciation expense during the period
Depreciation expense is the portion of an asset's cost that is charged to an expense on the income statement over the course of the asset's useful life.
CapEx can also be estimated by using the following formula:
CapEx = Depreciation expense x (1 + Growth rate of fixed assets)
Growth rate of fixed assets is the percentage change in the net fixed assets from one period to another.
CapEx is a useful tool for evaluating an organization's financial performance and overall health, as well as for comparing it to other businesses or sectors. Some common ratios that use CapEx are:
CapEx to sales ratio: Sales revenue split by CapEx shows how much of the sales revenue is invested in fixed assets.
CapEx to operating cash flow ratio: Calculated by dividing CapEx by operating cash flow, this ratio shows the proportion of operational cash flow that is invested in fixed assets.
CapEx to depreciation ratio: The ratio of capex to depreciation expense shows how quickly fixed assets are being upgraded or replaced.
CapEx to net income ratio: Net income divided by CapEx shows how much of the net income is invested in fixed assets.
