Farwah Jafri | September 8 2023
Each corporation must allocate a portion of its financial resources, from cash reserves, profits, or borrowed funds, toward delivering goods and services to customers or expanding its operations. These financial disbursements can be classified into two primary categories based on their time frame – capital expenditure and revenue expenditure.
In this blog we will learn more about capital expenditure and operational expenditure, calculations regarding capex, and how both are different from each other.
Capital expenditures, often referred to as capex, encompass the outlays a company makes to acquire, preserve, or enhance long-term assets. These expenditures only occur occasionally and usually necessitate a substantial allocation of funds due to their substantial size.
Instances of capital expenditure include the procurement of machinery, parcels of land, office spaces, or other tangible assets. Furthermore, any expenses incurred by the company in acquiring intangible assets like patents, trademarks, or licenses also fall under the purview of capital expenditures.
The calculation of capital expenditure (capex) is as follows:
Capital Expenditure (capex) = Net increase in the value of property, plant, and equipment + depreciation expense
A company’s annual balance sheet typically provides information about the capital expenditure incurred during the year under the category of fixed assets. Depreciation pertains to the reduction in asset value over time due to wear and tear, with this depreciation expense being deducted annually, progressively diminishing the asset’s worth.
Capital expenditures can generally be categorized into two types:
These expenditures are essential to sustain growth. They encompass costs associated with regular machinery and equipment maintenance and upgrades.
These expenses enhance a company’s earnings potential. They encompass costs incurred in establishing new facilities or expanding into new markets or regions.
Such expenses can streamline a company’s operations, such as acquiring technology that enhances output efficiency while using the same quantity of raw materials or adopting more fuel-efficient machinery.
Revenue expenditures, also known as operational expenses or opex, encompass the company’s costs to maintain its day-to-day business operations. These expenditures are typically of a short-term nature and do not lead to the creation of lasting assets or long-term economic benefits. However, they remain indispensable for a company’s ongoing functionality.
Revenue expenditures include rent, salaries, commissions, freight charges, fees, transportation expenses, and fuel costs, among others. The nature of revenue expenditures may vary depending on the type of business, but their overarching purpose is to facilitate efficient ongoing operations.
A company’s profit and loss statement under the “expenses” category typically provides insight into its revenue expenditure. Since these expenditures do not result in asset creation, they are not recorded on a company’s balance sheet, and no depreciation expenses are associated.
The calculation of operating expenses (Opex) is as follows:
Operating Expense = Revenue – Operating Income – Cost of Goods Sold
Revenue expenditure represents the costs incurred in running the core operations of a business or entity within a specific accounting period. One can calculate operating expenses using the following formula:
Operating Expense (Opex) = Total Operating Costs
Total Operating Costs include all expenses directly associated with a business’s regular and ongoing operations. These expenses are typically incurred within a specific accounting period, such as a month, quarter, or year. They can include various categories of expenses, such as:
This represents the direct costs of producing goods or services the business sells. It includes costs like raw materials, labor, and manufacturing expenses. COGS is subtracted from revenue to calculate gross profit, not Opex.
Operating income refers to the profit generated from a company’s core operations before accounting for interest expenses and taxes. It’s also not subtracted from revenue to calculate Opex; it’s a component of a company’s overall profitability.
To calculate revenue expenditure (Opex), you add all the operating expenses incurred during the accounting period. Here’s an example:
Suppose you are running a small retail store and want to calculate August’s revenue expenditure. Your operating expenses for the month include:
1. Rent for the store: $2,500
2. Employee salaries and wages: $4,000
3. Utilities (electricity, water, etc.): $800
4. Office supplies: $200
5. Insurance premiums: $300
6. Advertising expenses: $500
To calculate the revenue expenditure for August, you would add up all these expenses:
Opex = Rent + Salaries + Utilities + Supplies + Insurance + Advertising
Opex = $2,500 + $4,000 + $800 + $200 + $300 + $500
Opex = $8,300
So, your retail store’s revenue expenditure (operating expenses) for August is $8,300. This represents the total amount of money you spent operating your business during that specific period.
|Capital Expenditure refers to expenses incurred for acquiring or constructing a fixed asset.
|Revenue Expenditure pertains to expenses incurred for the day-to-day operations and maintenance of the business.
|Capital Expenditure aims to enhance the income-generating capacity of the business.
|Revenue Expenditure is directed towards preserving the income-generating capacity, ensuring that assets remain in efficient working order.
|Capital Expenditure typically generates benefits over an extended period.
|Duration of Benefit
|Revenue Expenditure provides benefits for a maximum period of one year.
|Capital Expenditure incurs annual depreciation charges.
|No depreciation charges are applied to Revenue Expenditure.
|Capital Expenditure is not recorded in the trading or P/L Account.
|Inclusion in P/L
|Revenue Expenditure is included in the Trading or Profit and Loss Account.
|Capital Expenditure is documented in the Balance Sheet under Fixed Assets.
|Inclusion in Balance Sheet
|Revenue Expenditure is not listed on the Balance Sheet; instead, it impacts the profit and loss account.
Also Read: A Small Business Guide To Payroll Management
Farwah is the Product Owner of Monily. She has an MBA from Alliance Manchester Business School, UK. She is passionate about helping businesses overcome challenges that hamper their growth, which is why she is working at Monily to facilitate entrepreneurs to efficiently manage business finances and stay focused on growth.