Weighing CapEx versus OpEx for budget optimization
Tempo Team
Staying on top of cash flow, expenses, and accounting is essential to business health and investor confidence. To accomplish this, companies track two types of expenditures: capital expenses (CapEx) and operational expenses (OpEx).
In terms of operating versus capital expenses for projects, the difference between the two impacts how you manage budget and resource allocation. Learning to differentiate between CapEx versus OpEx in project financial management helps you make better informed and more strategic budgetary decisions.
What are capital expenses?
CapEx refers to significant, long-term projects or expenditures that, once implemented, improve an organization’s fiscal performance, production capacity, or project quality. They generally involve periodic and fixed spending on physical and tangible assets such as plant, property, and equipment (PP&E).
These expenses typically provide economic utility for longer than one fiscal year and are generally the most significant expenditure for a company, with the assets procured representing the organization’s core business strategy and supporting long-term growth.
CapEx expenditures include:
Manufacturing equipment
Facility additions and upgrades
Computer and network equipment
Company vehicles
Heavy equipment and machinery
What are operational expenses?
OpEx regards all recurring day-to-day spending required to keep a company functioning. These are the costs of doing business — line items on the balance sheet that either help the organization manufacture goods, offer services, or attract customers. The benefits from these expenses are near-term, meaning the company feels the impact of spending its OpEx budget within a fiscal year.
Some OpEx expenses include:
Property or facility rent
Utilities
Payroll and salaries
Overhead costs
Property taxes
Research and development (R&D)
CapEx versus OpEx: 7 key differences
While the line between CapEx and OpEx seems blurry, the two have very different impacts on a company’s budgeting, reporting, and cash flow. Here are seven crucial differences.
1. Size
While both expenditures improve a company’s operations, they differ in the scope of their impact. OpEx spending covers the daily, weekly, monthly, and annual expenses that keep the lights on and the doors open. And CapEx spending involves large costs expected to impact the organization’s long-term capacity and profitability.
2. Timeline
A CapEx expenditure incurs an upfront payment, usually from a fund dedicated to PP&E purchases. OpEx are expenses incurred regularly, so you’ll generally pay them weekly, monthly, or annually.
3. Approval
Because of their impact and the high initial disbursement, companies consider CapEx projects a high-stake decision they can’t reverse. Before committing, CapEx planning requires a rigorous round of business case development, research, and analysis before undergoing multiple levels of individual and panel approvals.
And since companies recognize OpEx spending as a business necessity, affecting only the short-term, they rarely undergo an approval process. Generally, managers review operating expenses at year-end to forecast the next year’s budget and identify any spending outside the historical norm.
4. Control
Companies typically purchase a CapEx asset outright, so teams control its operation and maintenance. This allows them to customize the equipment to suit their needs, and if there’s a team dedicated to upkeep, the company can reduce the operating cost by not contracting out to a third party. If the company leases a piece of technology or property as an OpEx expense, it doesn’t have that kind of control but won’t need to concern itself with service and support.
5. Accounting
How the accounting department handles capital and operating expenses is the biggest difference between the two. CapEx projects aren’t tax deductible and, therefore, are included in the company’s cash flow statement for the period the team expensed the cost.
If the newly acquired asset is tangible (like a new piece of equipment), over time, its value depreciates. The company can claim the depreciated value after a waiting period as a tax deduction. And if the asset is intangible (like a patent or license), the cost is amortized over the asset’s economic life cycle. Amortization is deductible, reducing the company’s overall tax liability.
Accounting strictly tracks asset purchase and depreciation, providing stakeholders and investors with a clear picture of the organization’s financial well-being. And they deduct OpEx items during the period incurred, with teams expensing these items and including them in their income statement.
6. Budgeting
Companies fund capital and operational expenses differently, creating a dedicated pool to finance CapEx projects and using general funds for OpEx items.
Because CapEx projects involve a significant initial investment, the company only approves a few initiatives annually, budgeting for CapEx by:
Creating a separate capital expenditure budget
Soliciting input at the departmental and organizational level
Setting a budget limit
Assessing every CapEx project’s potential return on investment (ROI)
Companies establish an operations budget by reviewing historical budgeting data and adjusting for inflation, creating a forecasted cost for the upcoming year. This information provides insight into projected revenue and profit for the next quarter or year.
Budgeting for OpEx items includes:
Historical trend analysis
Market trend analysis
Inflation rate review
7. Investment
CapEx and OpEx give investors different perspectives on a company’s financial health. Comparing CapEx to operating cash ratios allows stakeholders to assess the amount of money a company dedicates to capital expenditures. A high ratio reflects significant growth objectives, while a lower value suggests the company has matured.
OpEx analysis helps investors understand how an organization distributes its budget and allocates funds. Comparing OpEx against net sales showcases management effectiveness, providing insight into sales performance and revenue.
It’s important to note that some projects involve both CapEx and OpEx items. If a company establishes a data center, the building, networking infrastructure, and office equipment are capital expenditures. And the money it spends purchasing office supplies, utilities, and coffee and snacks are operating expenses.
CapEx versus OpEx: How to balance both budgets
Most companies require budgeting for both capital and operational expenses, but it can be difficult to choose which to prioritize for various projects and company goals. Here are a few things to consider when deciding which expense to make:
Financial strength: Owning capital assets means you don’t have to continue paying for valuable equipment, which can improve your business’s financial position.
Taxes: As an asset’s value decreases over time, it produces a tax benefit when you claim it as a depreciation expense at year-end.
Investors: Reporting capital assets on the balance sheet indicates a higher profit and asset value to investors and other key stakeholders.
Potential losses: A company can’t replace or walk back a capital investment without incurring significant losses. If the company projects substantial growth or technological changes in the coming years, it’s better to choose an OpEx option.
Costs: Because of the significant investment, CapEx projects require accurate projections, careful budgeting, and precise project cost tracking.
Return on investment: Estimating future requirements and the rate of technological change is essential to extending an asset’s ROI.
Effective project cost tracking with Strategic Roadmaps by Tempo
Whether tracking a single CapEx project or managing multiple OpEx initiatives, creating project visibility with Tempo’s Strategic Roadmaps and Cost Tracker platforms helps you better manage budgets. These audience-friendly roadmaps and accurate timesheets streamline everything from team collaboration and project management to IT software initiatives and general product development.
