How to Calculate Capital Expenditures (Definition and Use)

By Indeed Editorial Team

Published 20 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Calculating a company's capital expenditures is a critical step to understanding its financial health. The term describes the money that a company spends to acquire or improve its long-term assets. Learning how to calculate capital expenditures can help you when making decisions about the future of a company or making investment decisions. In this article, we define the term in greater detail, show you how to do this in four steps, outline its importance, explain how you can use it for your benefit and answer some frequently asked questions.

What are capital expenditures?

Capital expenditures are funds that a company uses to acquire or upgrade physical assets such as property, buildings or equipment. They vary depending on the industry but typically include items like land, machinery, vehicles or office furniture.

The purpose of capital expenditures is to generate future revenue by expanding the company's operations or increasing its productivity. The directors or senior management usually make decisions on expenditures.

Related: 8 Financial Career Options (Plus Top Jobs and Salaries)

How to calculate capital expenditures

This is a step-by-step guide on how to calculate capital expenditures:

1. Look at the financial statements

The first step is to find the company's financial statements. This can give you an overview of the company's current assets and liabilities. Preferably, find the statements from the last two years. These can give you the information you use when calculating capital expenditures.

Related: Why Is Accounting Important? With Benefits of Accounting Career

2. Subtract the fixed assets

Once you have your financial statements, subtract the fixed assets. Take the fixed assets from last year and subtract them from the current year. This shows you the difference between them, namely what changed.

Afterwards, determine what the intangible assets are and eliminate them. This is because capital expenditure uses only tangible assets. For example, intangible assets can include goodwill and intellectual property. Also, you can ignore any assets that the company received through recent acquisitions, meaning within the reporting period.

3. Subtract the accumulated depreciation

After you finish subtracting the fixed assets you can pay attention to the accumulated depreciation. This is the total value of depreciation charged against the assets of the company up to that point. You can find this number on the balance sheet. To get the current year's total depreciation, subtract last year's accumulated depreciation from the current year.

4. Add the total depreciation

After you find the value of the total depreciation, you can add it to the number you found in step two, namely the change in fixed assets. Doing so gives you the total capital expenditures for the period you want to measure. You can use the formula below during your calculations with the help of your income statement and balance sheet.

PP&E means property, plant and equipment. You can find this on the company's balance sheet. They're long-term physical assets necessary for business operations and for the company's future financial health. They can include machinery, land, computers and furniture. This is the formula:

Capital expenditures = PP&E (Current period) - PP&E (Prior period) + Depreciation (Current period)

Why are capital expenditures important?

Capital expenditures are important because they represent a significant outlay of carefully managed cash that aims to generate a positive return on investment. They can also have a major impact on the long-term financial health of the company.

For example, a company that makes a large capital expenditure on new machinery may see its profits increase over the next few years as a result of its increased efficiency and productivity. Alternatively, if the company fails to properly manage the cash flow associated with the capital expenditure, it might be in financial trouble later in the future.

Related: Traders vs. Investors: Definition and Key Job Differences

How you can use capital expenditures

Here are a few different ways you can use capital expenditures to your advantage:

Company strategy

You can use capital expenditures to get an idea of a company's strategy and priorities. This can help you make investment decisions. For example, you may want to invest in a company that's investing heavily in new machinery, as this may indicate that the company is planning to expand its operations or enter new markets.

Financial health of the company

You can also use capital expenditures to get an idea of the financial health of a company. A company with a healthy balance sheet and strong cash flow usually finds it easier to make capital expenditures than a company that's struggling financially. This information can also be helpful when making investment decisions. For example, you may want to invest in a company that's making large capital expenditures as this may be a sign that the company is doing well financially.

Related: What Are Cash Cows? (Definition, Benefits and Example)

Health of the economy

Finally, you can use capital expenditures to know about the overall health of the economy. For example, if companies are investing heavily in new factories and equipment, it's typically a sign that they expect future economic growth. This information can be helpful when making financial decisions for a company.

Remember to also conduct further independent research before making any big decisions. This is because the industry's capital expenditure is only one factor to consider when determining general economic health. Other factors include the employment rate, consumer confidence, interest rates and inflation.

Related: What Is Inflation Rate? (With Definition and Examples)

FAQ on capital expenditures

These are some frequently asked questions and their answers:

What are some factors that a company can consider when making a capital expenditure?

When making a capital expenditure, it's crucial that the company carefully considers several factors, including:

  • The expected life of the asset: Namely, how long the company expects to use the asset before it's time for a new replacement.

  • The expected return on investment: This relates to how much money the company expects to make as a result of the expenditure.

  • The impact on cash flow: This means whether or not the company expects to have enough money to cover the cost of the expenditure upfront. If they don't have the necessary funds, it's also important for them to know how they can finance the purchase.

  • The impact on the balance sheet: They also consider whether or not the expenditure might increase or decrease the company's overall value.

  • The taxation implications: The company contemplates the taxation implications of the expenditure and whether or not the company can receive any tax breaks as a result of the purchase when making its decision.

How can capital expenditures impact the economy?

Capital expenditures can have a significant impact on the economy, both in the short and long term. In the short term, they can provide a boost to economic activity by increasing the demand for goods and services. This can lead to increased employment and wages as businesses expand to meet the increased demand.

In the long term, capital expenditures can increase productivity and economic growth. They can do this by increasing the amount of capital available for businesses to use which can lead to the development of new and more efficient technologies and processes. This can make businesses more competitive and increase their output, thereby leading to higher levels of economic activity.

Related: How to Prepare a Statement of Retained Earnings in 5 Steps

What's the difference between capital expenditure and operating expense?

A capital expenditure results in the acquisition of a long-term asset, such as land or equipment. An operating expense is a cost incurred in the day-to-day operations of a business, such as salaries, rent and utilities. The purpose of capital expenditure is typically to grow or expand a business, while operating expenses try to maintain the current level of operations.

Related: Capex vs Opex: Differences, Importance and Examples

How is a capital expenditure different from an investment?

A capital expenditure represents a long-term investment in a company because it results in the acquisition of long-term assets. Meanwhile, an investment is an expenditure made with the aim of generating a future return, such as investing in stocks or bonds. Frequently, capital expenditures use borrowed funds while investments use personal or equity funds.

What are some examples of capital expenditures?

Capital expenditures can vary depending on the industry. Some common examples include:

  • construction of a new factory

  • purchase of new machinery or equipment

  • expansion of a current business

  • development of a new product line

  • acquisition of another company

  • research and development expenses

Does capital expenditure affect profit?

In its basic form, a capital expenditure is an investment that a company makes. The cost of this investment isn't immediately reflected on the company's income statement. This cost instead gradually deducts from the income statement over the life of the asset. There are other ways that a capital expenditure can impact the income statement, depending on the type of asset the business purchases.

For example, if a company purchases land, the cost of the land doesn't appear on the income statement until it gets sold. Meanwhile, if a company builds a factory, the cost of the factory appears on the income statement over the life of the factory. In both cases, the capital expenditure affects profit by reducing it. Despite this, capital expenditures can lead to an increase in future profits by promoting productivity levels and encouraging financial growth.

Explore more articles