Capital expenditures or CapEx refers to the money a company spends or invests to promote its future growth. This is different from operating expenditures, which deal with the day-to-day costs of running a business. Both show up on a business accounting statement, and both matter for maintaining a healthy bottom line.
From an investment perspective, understanding capital expenditures and how a company spends its money can be useful for evaluating stocks when deciding where to invest. More specifically, the capital expenditure formula is often part of a fundamental analysis approach to gauge a company’s overall financial health and stability.
Understanding how to calculate capital expenditures can be helpful when comparing stocks.
Capital Expenditures: Definition & Overview
Here’s a simple definition of capital expenditure: A capital expenditure is any amount of money that a company spends to further its growth.
Capital expenditures typically include the purchase, improvement, or maintenance of physical assets, though it can also refer to intangible assets, such as patents or trademarks. It includes assets that a company will own over more than one accounting period, many of which can depreciate in value over time.
Types of Capital Expenditures
The type of capital expenditures a company has depends on the industry it belongs to and the nature of its business. So, if you’re sector investing, the analyses may vary. Generally, capital expenditure examples can include:
• Land
• Buildings or warehouses
• Equipment
• Machinery
• Business vehicles
• Computer hardware and/or software
• Furniture or fixtures
• Patents
• Licenses
Capital expenditures are most often long-term investments that have a shared goal: to help promote or further business growth. For example, a manufacturing company may decide to upgrade its equipment to speed up production and increase efficiency. The return on that investment comes later, when the company increases its output and generates bigger profits.
Capital Expenditures vs. Operating Expenditures
In accounting, capital expenditures are separate from a company’s operating expenditures. An operating expenditure is money a company spends to maintain normal business operations.
Examples of operating expenditures include:
• Rent or lease payments for business property
• Utilities
• Insurance
• Employee payroll
• Inventory
• Marketing costs
• Office supplies
Bottom-up investors use both capital expenditures and operating expenditures to measure how a company spends its money, but it’s important to avoid confusing them. In a nutshell, capital expenditures represent long-term investments in assets that will be used in the future, while the operating expenditures represent short-term outlays.
How to Calculate Capital Expenditures
Companies calculate capital expenditures and include it on their cash flow statements under the section noted for investing activities. If you have access to a company’s cash flow statement, you wouldn’t necessarily need to calculate capital expenditures because the relevant numbers would already be included.
But if you don’t have cash flow information available, or you simply want to do the math on your own, there’s a capital expenditures formula you can use. This formula is simple, though it does require that you have certain information about a company’s financial situation, including:
• Depreciation and amortization for capital expenditure assets
• Current period PP&E (Property, Plant & Equipment)
• Prior period PP&E
Property, Plant & Equipment refers to assets listed on a company’s balance sheet. In simpler terms, these are the assets that help generate revenue and profits for the business. So again, this can include things like equipment, machinery, vehicles, office equipment or land. Of those assets, land is the only one that typically doesn’t depreciate in value over time.
If you have these three pieces of information, you can then apply the capital expenditures formula. The formula looks like this:
CapEx = Current period PP&E – Prior period PP&E + Current period depreciation
Here’s how it works using hypothetical numbers. Say you’re evaluating a company that has a current period PP&E of $70,000, a prior period PP&E of $50,000 and $20,000 in current period depreciation. Your capital expenditures formula would look like this:
CapEx = $70,000 – $50,000 + $10,000
CapEx = $30,000
These calculations are relatively easy to do if you have all the relevant details from a company’s balance sheet. Once you can calculate capital expenditures, you can use the formula to evaluate investments.
Capital Expenditures and Fundamental Analysis
Fundamental analysis is one strategy for comparing investments and it’s typically used when investing for the long-term. With this type of analysis, the emphasis is on what makes a company financially healthy. This is something you may be interested in when trying to evaluate a stock appropriately and decide whether to invest in it.
A fundamental analysis approach considers a company’s assets and liabilities. But it also utilizes certain financial ratios that measure how money moves in and out of the company. Some of the most important ratios include:
• Price to earnings (P/E) ratio
• Earnings per share (EPS)
• Current ratio
• Quick ratio
• Return on equity (ROE)
• Book-to-value ratio
• Projected earnings growth (PEG)
All of these ratios measure a company’s value, which is important if you’re using a value investing approach. The goal there is to identify companies that have been undervalued by the market but have long-term growth potential. By investing in these companies and holding on to them, investors can benefit from price appreciation as they rise in value over time.
So where do capital expenditures fit in?
In terms of gauging a company’s value, capital expenditures offer insight into projected growth over the long-term. When a company regularly invests money in purchasing or upgrading assets, that can be a sign of financial strength and an eventual increase in value. On the other hand, a company pulling back on capital expenditures may hint at cash flow struggles that are impeding future growth.
One thing that’s important to keep in mind is that capital expenditures aren’t a foolproof indicator of a company’s long-term growth potential. It’s possible that a company may spend money with good intentions, only to have them backfire.
In an earlier example, we mentioned a manufacturing company purchasing new equipment to boost production. If that investment doesn’t pan out as expected–if, for example, the equipment requires constant maintenance and repairs that eat into profits or it falls short of expectations for increasing production speed–that could inhibit the company’s growth plans.
Recommended: How to Use Fundamental analysis for Researching Stocks
The Takeaway
Capital expenditures can be particularly helpful to investors if you favor a value investing approach or you lean toward buy-and-hold investing. Understanding how a company is investing in itself for the long-term can help you decide whether it makes sense as part of your portfolio.
Once you’re ready to invest, it’s important to choose the right tools for doing so. Online investment platforms like SoFi Invest make it easy to build a portfolio of stocks and exchange-traded funds (ETFs), whether you’re a beginner or an experienced trader.
You can start investing with as little as $5 with fractional share trading. It’s easy and convenient to manage your portfolio online or via the mobile app. Whether you’re investing for the short- or long-term, SoFi Invest can help you reach your financial goals.
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