CapEx

Definition

CapEx, or capital expenditure, refers to the funds used by a company to acquire, upgrade, or maintain physical assets such as property, buildings, equipment, or technology. CapEx is an important consideration in the context of a company's income statement and its operating cash flow and free cash flow to the firm.

5 Must Know Facts For Your Next Test

1. CapEx represents the cash outflow for the purchase or improvement of long-term assets, which are recorded on the balance sheet rather than the income statement.
2. CapEx is considered an investment, as it is expected to generate future economic benefits for the company.
3. The decision to invest in CapEx is influenced by factors such as the company's growth strategy, the need to replace or upgrade existing assets, and the expected return on the investment.
4. Depreciation expense, which is recorded on the income statement, represents the allocation of the cost of CapEx over the useful life of the asset.
5. CapEx is a key component in the calculation of a company's free cash flow to the firm (FCFF), which is an important measure of a company's financial performance and ability to generate cash for shareholders and lenders.

Review Questions

• Explain how CapEx is recorded on the income statement and its impact on a company's profitability.
  • CapEx is not directly recorded on the income statement, as it represents the purchase or improvement of long-term assets. However, the depreciation expense associated with these assets is recorded on the income statement as an operating expense, which reduces the company's reported profits. While CapEx is an outflow of cash, it is considered an investment that is expected to generate future economic benefits for the company, and its impact on profitability is reflected through the depreciation expense over the asset's useful life.
• Describe the relationship between CapEx and a company's operating cash flow (OCF).
  • CapEx has a direct impact on a company's operating cash flow (OCF). OCF represents the cash generated from a company's normal business operations, excluding the impact of financing and investing activities. Since CapEx is considered an investing activity, it is not included in the calculation of OCF. However, the depreciation expense associated with CapEx is added back to net income when calculating OCF, as it is a non-cash expense. Therefore, CapEx represents a cash outflow that reduces a company's OCF, while the depreciation expense helps to offset this impact.
• Analyze the role of CapEx in the calculation of a company's free cash flow to the firm (FCFF) and its significance in evaluating the company's financial performance.
  • CapEx is a critical component in the calculation of a company's free cash flow to the firm (FCFF), which is an important measure of a company's financial performance and its ability to generate cash for shareholders and lenders. FCFF is calculated as the operating cash flow (OCF) minus the capital expenditures (CapEx) required to maintain the company's existing assets and support its ongoing operations. By subtracting CapEx from OCF, FCFF represents the cash available to all providers of the company's capital, including shareholders and lenders, after the company has made the necessary investments in fixed assets and working capital. A higher FCFF indicates that the company has more cash available for dividends, debt repayment, or other strategic investments, and is generally seen as a positive indicator of the company's financial health and growth potential.

Related terms

Depreciation: The systematic allocation of the cost of a physical asset over its useful life, which is recorded as an expense on the income statement.

Operating Cash Flow (OCF): The cash generated from a company's normal business operations, excluding the impact of financing and investing activities.

Free Cash Flow to the Firm (FCFF): The cash available to all providers of a company's capital, including shareholders and lenders, after the company has made all the necessary investments in fixed assets and working capital to support ongoing operations.