Capital expenditure (capex) is a business expense that is characterized by the use of company funds for physical assets. The funds can be used to purchase physical assets such as buildings, equipment or property. They can also be used to upgrade existing assets – installing a new roof on a building, for example. The use of these funds is designed to create future benefits to the company – either through the expansion or increasing the value of non-consumable assets through upgrading. Capex is money spent with the intention of increasing future cash flow – resulting in a large return on investment. Capex is an investment in the future of a company.
Typically, there are two forms of capex that companies use: maintenance and expansion (or growth).
- Maintenance capex occurs when a company extends the life of current assets by purchasing additional assets. A trucking company, for example, that purchases new tires for one of its trucks is using maintenance capex. The value of the truck is not changing with the addition of the tires; it is an investment that will help to generate more revenue over the two year life of the tires.
- Expansion capex, also sometimes referred to as growth capex, occurs in our trucking example when a company purchases another truck to add to their motor pool. The investment in the truck is spent with the anticipation that the truck will generate additional revenue for the company.
It is beneficial to a company to distinguish between the two types of capex – it allows for more detailed accounting reporting about the expansion and free cash flow of a company. Understanding the business model used by the company is key in determining the most appropriate form of capex that should be used. Different industries will require different amounts of capex, and many industries will go through periods of expansion, driving the capex levels at different times.