Capital expenditures are money a company spends to buy, maintain, or improve its fixed assets — like buildings, equipment, or technology — that will benefit the business over the long term.
Operating expenses are costs for running the day-to-day operations of a business.
- For capital expenditure, no expenses in the year of acquisition of the assets, but annual depreciation over the asset’s life in following years.
- In operating expenses, all expenses are deducted on income statement in the year of acquisition of the asset. And on depreciation afterward.
- If the acquisition of assets is treated as operating expense, both earnings and cash would decline by the amount of after-tax expenses in that year.
Let’s say a company buys a piece of equipment for $10,000.
- If treated as CapEx:
- In Year 1, no expense is recorded for the purchase.
- Each year, $1,000 in depreciation is expensed over 10 years (assuming straight-line depreciation).
- Earnings in Year 1 are unaffected, but each subsequent year will show $1,000 less in profits due to depreciation.
- The company spends $10,000 in cash in Year 1, but the impact on earnings spreads over the next 10 years.
- If treated as OpEx:
- In Year 1, the entire $10,000 cost is expensed.
- Earnings in Year 1 would decrease by $10,000 (less tax savings).
- Cash flow in Year 1 would be impacted by the purchase cost of the asset, but no future depreciation expense is recorded.