Capital Expenditure vs. Operational Expenditure: Key Differences for CEOs

7 min read

October 15th, 2024

All business expenses represent money out the door, but the way you categorize these expenses has greater implications than reduced net income.

There are two basic categories of costs in business and all expenses fall under either capital expenditures or operational expenditures. Understanding the difference helps CEOs improve their reporting, compliance, financial planning, and business strategy.

All business expenses represent money out the door, but the way you categorize these expenses has greater implications than reduced net income. There are two basic categories of costs in business and all expenses fall under either capital expenditures or operational expenditures. Understanding the difference helps CEOs improve their reporting, compliance, financial planning, and business strategy.

Capital Expenditure vs. Operational Expenditure Differences

What Is a Capital Expenditure?

A capital expenditure (CapEx) is a long-term investment in a physical asset, such as property, plant, or equipment (PP&E). Capital expenditures are capitalized and depreciated over time. As a result, capital expenditures appear on the balance sheet under assets and on the cash flow statement under investments.

How to Calculate and Identify a Capital Expenditure

CapEx = (Prior Period PP&E - Current Period PP&E) + Current Period Depreciation

Capital expenditures provide a lasting benefit to the business (i.e. one that lasts longer than the current financial period or about 12 months). These types of expenses usually have high initial costs but are intended to improve the business's operations in the long run. CapEx purchases are typically viewed as investments that will help the business to operate, grow, and generate more value over time.

CapEx Examples

Common capital expenditures include:

• Building construction or renovation
• The purchase of tangible, fixed assets (equipment, vehicles, or machinery)
• The purchase of intangible assets (trademarks or patents)
• Research and development
• Upgrades or repairs to extend the life of existing assets (equipment, technology, or software)

Read More: The Pros & Cons of Outsourced Accounting Services

What Is an Operational Expenditure?

An operational expenditure (OpEx) is a short-term, daily, operational cost that is expensed immediately. As a result, operational expenditures appear on the income statement under expenses.

How to Calculate and Identify an Operational Expenditure

OpEx = COGS + Operating Expenses

Operational expenditures are necessary for the day-to-day operation of a business. They are necessary and keep a business running smoothly by maintaining its physical locations and processes, but they do not generate future value beyond the current financial period. In other words, they are viewed as expenses, but not necessarily as investments. Operational expenditures help to satisfy the immediate needs of a business's operation.

OpEx Examples

• Rent and utilities
• Salaries
• Administrative costs
• Insurance
• Property taxes
• Interest on loans
• Supplies

How to Differentiate CapEx and OpEx in Business: CapEx vs. OpEx at a Glance

What Are the Implications of the Two Types of Spending? The Key Differences Between CapEx and OpEx for CEOs

For most businesses, both capital expenditures and operational expenditures are necessary for success, and finding the right balance between the two will help your business operate efficiently, prudently, and with an eye on the future.

For most CEOs, money spent in a business is seen as money out the door - regardless of the type of expenditure - and both capital expenditures and operational expenditures reduce a business's net income. However, the difference between capital expenditures and operational expenditures (i.e. the manner in which they reduce net income) has implications of which business leaders should be aware.

The primary differences for CEOs to consider are how the two types of expenses are treated in terms of taxes and business valuation:

• Operational expenses are immediately deductible, meaning they can reduce your income tax obligations in the current period using their full value. They also impact the company's income statement, where they appear as expenses.
• Capital expenditures must be depreciated. So, they can be deducted, but the total deductible value is spread out over the expense's useful lifetime. While this limits the tax benefits in the current year, it does help to reduce the impact on a company's bottom line by spreading out the cost over a longer period of time through capitalization and depreciation.
• Listed within the company's assets on the balance sheet and reflected as an investment on the income statement, capital expenditures add to the value of a business.

It is also important for CEOs to weigh the benefits of each type of expense. While operating expenditures are typically less expensive and produce an immediate benefit to the business, capital expenditures often offer a greater overall benefit to a business that is incurred more slowly over a longer period of time.

Typically, CEOs need to think about the two types of expenditures separately by planning and budgeting for them in different ways.

Read More: Financial Reports vs. Management Reports: What’s the Difference?

Expenditure Management: The Ups and Downs of CapEx and OpEx

Both capital expenditures and operating expenditures present some challenges and benefits that business leaders should be watching out for.

Benefits of CapEx

Business revolves around the idea of investment, doing work and spending money now to turn a profit in the future, and capital expenditures support this concept.

• Acquiring long-term assets helps to support stability and sustain growth.
• Investing in new technologies and equipment can help improve efficiency, reliability, and productivity for better long-term performance.
• Long-term investments can gain your business a competitive advantage.
• Capital expenditures increase your business valuation.
• Long-term investments provide long-lasting tax benefits with gradual depreciation.

Challenges of CapEx

Capital expenditures are highly dependent on future performance, continued strategy, and budget forecasting. So, managing capital expenditures presents some challenges around budget allocation, regulatory compliance, managing future risks, and measuring ROI. Additionally, large capital expenditures have a long-term impact, so it's important to spend wisely in this category.

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Benefits of OpEx

Operating expenditures provide flexibility and agility that allow business leaders to respond to a company's immediate needs.

• OpEx spending can quickly be adjusted in response to the market, economy, and current initiatives.
• The full amount of operating expenses is immediately recognized on the income statement.
• These expenses are fully tax-deductible in the current financial period.
• Recurring operating expenses are easy to anticipate and budget for.
• These expenses can be more easily adjusted from month to month, giving businesses greater control over this category of spending.

Challenges of OpEx

The flexibility found in operating expenditures can also present some challenges to a business's financial health. For example, markets fluctuate unpredictably, and these external factors can make operational costs (such as talent acquisition and retention, supply costs, and technology costs) difficult to control.

Read More: How Much Do Outsourced CFO Services Cost?

Balance Your Expenditures and Maintain Sound Financial Data With an Outsourced Accounting Department

Taking the time to differentiate between different types of expenses while keeping track of your budget and depreciation schedules is a lot to juggle - especially while you're trying to run a whole business. For CEOs who feel overwhelmed by their back offices or spend too much of their time on day-to-day back-office processes, an outsourced back office can be the perfect solution.

Outsourced accounting can free up your time so you can focus on running your business while providing you with streamlined processes to automate your bookkeeping and accounting function, ensuring you have up-to-date and accurate reports at your fingertips and the financial information you need to make data-driven decisions to lead your business to a more successful future.