Capital expenditures (CapEx) — clear explanation
Definition
– Capital expenditures (CapEx) are cash outlays a company makes to buy, upgrade, or extend the life of long‑lived physical assets (property, plant, equipment, major software, etc.). These costs are capitalized on the balance sheet and written off over the asset’s useful life as depreciation (or amortization for intangible assets).
Why CapEx matters
– CapEx shows how much a firm is investing to maintain or grow its productive capacity. High CapEx can signal expansion or heavy maintenance needs; low CapEx in capital‑intensive industries may indicate underinvestment. CapEx affects cash flow, future depreciation expense, and measures like free cash flow.
Where CapEx appears in financial statements
– On the cash flow statement: reported in investing activities (often labelled “purchase of property, plant & equipment,” “capital expenditures,” or “PP&E purchases”).
– On the balance sheet: changes appear in the PP&E (property, plant & equipment) line.
– On the income statement: depreciation expense related to capitalized assets appears periodically.
How to calculate CapEx from public financials — step‑by‑step checklist
1. Obtain the company’s balance sheets for the current and prior period and the current period income statement (or cash flow statement).
2. From the balance sheets, note:
– PP&E (gross or net, depending on disclosure) at the end of the current period and prior period.
3. From the income statement, note:
– Depreciation expense for the current period.
4. Use the common accounting identity:
– CapEx = Change in PP&E + Depreciation
– ΔPP&E = PP&E_end − PP&E_begin
– Depreciation = depreciation expense for the period
– (This works when PP&E figures are net of accumulated depreciation; if gross PP&E and accumulated depreciation are available, adjust accordingly.)
5. Cross‑check against the investing activities section of the cash flow statement; the “purchase of PP&E” line should match or be close.
Small numeric worked example
– Given:
– PP&E at beginning of year = $1,000
– PP&E at end of year = $1,200
– Depreciation expense during year = $150
– Compute:
– ΔPP&E = 1,200 − 1,000 = $200
– CapEx = ΔPP&E + Depreciation = 200 + 150 = $350
– Interpretation:
– The company spent $350 on new or improved fixed assets during the year. If operating cash flow for the year is $500, the cash‑flow‑to‑CapEx ratio = 500 / 350 ≈ 1.43 (suggesting operations generated enough cash to fund these investments).
Common variations and related formulas
– Free cash flow to equity (FCFE) is often adjusted for CapEx because higher CapEx reduces cash available to shareholders. Two equivalent forms you may see (variables defined after):
1) FCFE = EP − (CE − D) × (1 − DR) − ΔC × (1 − DR)
– EP = earnings per share (or aggregate earnings)
– CE = CapEx
– D = depreciation
– DR = debt ratio
– ΔC = change in net working capital
2) FCFE = NI − Net CapEx − ΔNWC + New Debt − Debt Repayments
– NI = net income
– Net CapEx = capital expenditures net of any asset sales
– ΔNWC = change in net working capital
– New Debt = borrowings during period
– Cash‑flow‑to‑CapEx ratio = Operating cash flow / CapEx. A ratio > 1 suggests operations are generating cash sufficient to fund capital spending; operating cash flow over time can signal funding pressure.
Common pitfalls and adjustments
– Negative reported CapEx: This can occur when asset sale proceeds exceed gross additions in a period — interpret as net divestiture, not “negative investment.”
– Excluding acquisitions: CapEx excludes business acquisitions; treat those separately when evaluating organic reinvestment.