The distinction between capital expenditure (CAPEX) and operating expenditure (OPEX) may seem like a subtle one. Both involve spending money for the benefit of the business. More complex expenditures may involve both types of expense. In broad strokes, the line between the two seems fuzzy at best.
Despite the similarities, it’s crucial for the health of a business to keep CAPEX and OPEX separated. Confusing or conflating the two can lead to everything from tax troubles to cash flow problems. On the other hand, keeping each in their own well-defined role can help boost efficiency and streamline budgeting and forecasting.
Here’s everything you need to know about CAPEX and OPEX.
What Is CAPEX?
Capital expenditure is money invested to purchase, maintain or upgrade both physical and intangible assets. For example, purchasing a new software platform or upgrading machinery on a factory floor would both be considered CAPEX.
Defining characteristics of CAPEX include:
- Provide long-term benefits
- Substantial monetary investment
- High value, impact and risk
- Enable growth and sustainability when done properly
- Negatively impact the business if unwisely invested and may be hard to reverse
Because of the high-stakes nature of CAPEX decisions, the process tends to be long and complex:
- Wishlist proposals are created and considered in preparing an annual capital expenditure budget.
- More detailed business cases are prepared and submitted as Capital Expenditure Requests (CER’s) for approval.
- Depending on their value and motivation, authorization for expenditure (AFE) requests may require multiple levels of individual and panel approval.
- Once a capital project is approved, supplementary budget funding may be requested based on forecast expenditures.
- On completion of a capital project, the accumulated costs are settled to a fixed asset, and any unused budget is returned to the funding pool for redeployment.
- Post-investment reviews evaluate project outcomes and improve future project definition and selection.
What Is OPEX?
Operating expenditures are the recurring expenses that businesses must pay to keep the organization running, like employee wages, equipment rentals, and office supplies. While CAPEX is intended to increase the long-term value of the business, OPEX is about keeping the lights on and the business productive.
Defining characteristics of OPEX include:
- Provide short-term benefits.
- Tend to be a lower up-front cost.
- Recurring, predictable, and flexible expenses.
- Part of day-to-day operating overhead.
- Less impactful to the business if inappropriate and can be more easily reversed.
For example, if a manufacturing company enters into a short-term operating lease for machines for the shop floor, the monthly payment would be OPEX. However, if they decided to purchase a fleet of new machines outright, that would be CAPEX. The former is a predictable, flexible, monthly expense, while the latter is a high-impact (and risk) investment in the company’s future.*
Why the Difference between CAPEX and OPEX Matters
There’s no denying that the CAPEX process can be complex and drawn out. So it’s no surprise that some businesses try to blur the line between CAPEX and OPEX to put more expenditures in the latter category. But the two types of expenditures have very different effects on the business’ budgeting, reporting and bottom line.
Operational expenditures are generally tax deductible, provided they are “ordinary and customary costs” to keep the business running. Capital expenditures, on the other hand, are not immediately deductible expenses, but can be depreciated over time to offset the investment cost. OPEX are listed as an expense and reported on the business’ income statement, while CAPEX are listed as assets and reported on the balance sheet.
Confusing or conflating the two can make it harder for the business to get a clear picture of its own assets and expenses—which can be especially problematic for tax purposes.
Granted, any new initiative might include both CAPEX and OPEX components. Both types of expenditure can benefit from analysis of a few key elements:
- Urgency (the risk of taking no action)
- Benefits (both qualitative and quantitative)
- Risk (probability of success)
- Strategic Alignment (matching the overall direction of the business)
How to Create A More Efficient CAPEX Process
The solution to an overly convoluted CAPEX process, then, is not to classify as many expenses as OPEX as possible. Instead, the goal should be to streamline CAPEX to reduce bottlenecks, increase speed and enable smarter decision making.
It may seem daunting to overhaul your organization’s CAPEX process; it’s likely a multi-departmental, multi-stage affair with plenty of stakeholders to appease. But it can be done.
Start by seeking to simplify the tech stack that underlies the process. If each department has its own proprietary platform for their piece of the puzzle, there’s plenty of room for improvement.
An end-to-end CAPEX solution can help:
- Facilitate communication
- Drive collaboration
- Reduce bottlenecks
- Simplify the process
- Provide data to optimize the next round of CAPEX
In addition, the right solution can seamlessly handle both CAPEX and OPEX on a single platform.
While CAPEX and OPEX are both essential parts of keeping a business operational and growing, CAPEX has traditionally been the slower and more painful process of the two. With the right solution and new processes, however, modern CAPEX can be far more streamlined and efficient than it is now.
*However, not all leases are OPEX, and not all purchases are CAPEX. A lease may be motivated by financing and taxation considerations, yet still be classified as an asset and approved in a similar way.
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