# An Ultimate Guide To Understanding Capex And Its Secrets

April 10 2023   |   By Farwah Jafri   |   5 minutes Read

###### Get professional bookkeeping from \$195 per month

Whether you’re an entrepreneur, or a business owner, understanding how to calculate CapEx is crucial to managing finances and making informed investment decisions. Capital Expenditure refers to the funds a company invests in its fixed assets, such as property, equipment, or machinery. These investments are made to improve the company’s productivity, efficiency, and profitability in the long term.

In this blog, we will provide a step-by-step guide on calculating CapEx and illustrate the concept with real-world examples. By the end of this guide, you will have a comprehensive understanding of CapEx and be equipped with the tools to make informed financial decisions for your business. So, let’s dive in and learn about the formula and examples for calculating CapEx!

## How Do You Know When to Capitalize and When to Expense?

To understand in a better way, there are a few factors to consider:

#### Useful life

The asset is generally capitalized if it has a useful life of more than one year. For example, if a company purchases a new machine for its manufacturing facility that is expected to last for five years, the cost of the machine would be capitalized.

#### Materiality

If the asset’s cost is relatively small, it may be expensed rather than capitalized. For example, if a company purchases office supplies such as paper and pens, these costs would be expensed rather than capitalized.

#### Maintenance

If the expense is incurred to maintain the asset’s current condition, it is typically expensed. For example, the repair cost would be expensed if a company repairs a machine to keep it running.

#### Increase in value

If the expense increases the value of the asset beyond its original cost, it is capitalized. For example, the cost would be capitalized if a company renovates a building to increase its value.

#### Intention

If the expense is incurred to generate revenue in the future, it is capitalized. For example, if a company develops software that it plans to sell, its cost would be capitalized.

## Formula and Calculations of CapEx

The formula for CapEx is:

PP&E (current period) – PP&E (previous period) + Depreciation (current period) = CapEx

#### Step 1: Identify the Asset

The first step in calculating CapEx is identifying the asset being acquired or upgraded. This could be a piece of equipment, a building, or a piece of land, for example.

Example: ABC Company is planning to purchase a new printing press.

#### Step 2: Determine the Cost of the Asset

Once the asset has been identified, the next step is to determine the cost of the asset. This includes not only the purchase price of the asset but also any associated costs, such as shipping, installation, and taxes.

Example: The purchase price of the printing press is \$50,000. Shipping and installation costs are estimated at \$5,000, and taxes are estimated at \$2,500. Therefore, the total cost of the asset is \$57,500.

#### Step 3: Determine the Useful Life of the Asset

The useful life of an asset refers to the period over which it is expected to provide benefits to the company. The company’s accounting policies typically determine this and may be based on industry standards or the company’s experience.

Example: The printing press is expected to have a useful life of 10 years.

#### Step 4: Determine the Salvage Value of the Asset

An asset’s salvage value is the asset’s estimated value at the end of its useful life. This value is used to calculate depreciation expense over the asset’s life.

Example: The salvage value of the printing press is estimated to be \$5,000.

#### Step 5: Calculate the Depreciation Expense

Depreciation expense is the portion of the asset’s cost allocated to each year of its useful life. Several methods can be used to calculate depreciation, but the most common are the straight-line and accelerated methods.

The straight-line method divides the asset’s cost by its useful life to determine the annual depreciation expense. On the other hand, the accelerated method applies a higher depreciation rate in the early years of the asset’s life and a lower rate in the later years.

Example: The annual depreciation expense for the printing press is calculated as follows:

(\$57,500 – \$5,000) / 10 = \$5,250 per year

#### Step 6: Calculate the CapEx

Finally, the CapEx can be calculated by adding up all the costs associated with acquiring or upgrading the asset.

Example: The CapEx for the printing press is calculated as follows:

Purchase price + shipping and installation + taxes = \$50,000 + \$5,000 + \$2,500 = \$57,500

Therefore, the CapEx for the printing press is \$57,500.

## Examples of Capital Expenditure

Some of the examples of CapEx include:

#### 1. Purchase of machinery, equipment, and vehicles

A company may spend money on acquiring new equipment or machinery to enhance its operations, increase production capacity, or improve the quality of its products.

#### 2. Construction of new facilities

A company may construct new buildings or facilities, such as a new manufacturing plant, research and development center, or warehouse.

#### 3. Upgrades to existing facilities

A company may spend money on upgrading its existing facilities to improve efficiency, increase capacity, or enhance its safety features.

#### 4. Investment in technology

A company may spend money on software, hardware, or other technological solutions to improve its operations, automate certain tasks, or enhance its products.

#### 5. Acquisition of other companies

A company may acquire another business to expand its operations or gain access to new markets, customers, or products.

## Conclusion

Calculating CapEx is an important part of financial planning for any company that acquires or upgrades fixed assets. By following the steps outlined in this blog, you can ensure that you accurately calculate CapEx and clearly understand the costs associated with your fixed assets.

MORE BLOGS

## You may also like

###### How to Optimize Your Accounts Payable Management for Maximum Efficiency

Effective accounts payable management is essential for any organization that wants to maintain its financial health. It involves the systematic process of managing and paying outstanding […]