CAPEX and OPEX – In corporate meetings, it is very common to hear two acronyms: CAPEX and OPEX. Many people know the meaning of the terms, but do not always understand what their concepts and applications are.
Basically, they understand ways to contract and purchase products and services, consisting of categories of business expenses. For this reason, they are fundamental ideas for controlling and monitoring spending, so that corporate finances are kept up to date.
However, it is necessary to go further in understanding what these concepts are, what their differences are and why they are necessary to the business. So we created this post. In addition to these points, we will show you how to calculate these indices and the most appropriate methodology for your company.
So, how about knowing more? Follow!
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Table of Contents
What are CAPEX and OPEX?
The explanation of these two concepts is quite simple, but you need to understand them very well so that there is no confusion. See the definition of each of them below:
CAPEX
Capital expenditure, or capital expenditures, represents investments or disbursements in capital goods, which are those used in the production of other items, such as equipment, construction materials, among others. In other words, it is the funds used to acquire elements that will help to increase the company’s ability to generate profit.
In simpler terms, it is related to the purchase of a good. Therefore, your expenses are used to purchase this type of item or physical services, for example, hardware. Note that capital expenditures also cover services.
Thus, active Purchases may refer to a new purchase or an item that increases the productivity of an industry or equipment. However, it is necessary to pay attention to the fact that the segment in which the business is inserted influences capital expenditure.
After all, if the asset has a useful life longer than the fiscal year, capitalization of expenses must be made from amortization – in the case of intellectual property – or depreciation – for tangible assets. The purpose is to share the cost of the element over the useful life indicated by tax regulations. Another relevant issue is that, in the case of investment analysis in projects, this index is the basis for calculating the return (ROI).
OPEX
Operational expenditure refers to operating expenses, which are payments related to business management and the sale of products and services. This is the case, for example, of a company that would buy a computer, but change to a service that delivers the machine and still monitors, trains employees and updates the system.
Therefore, it is like a “rent” of goods and provision of services. Its costs are related to the maintenance of equipment, the expenditure of consumables and more operating expenses. This means that this type of disbursement is carried out on a daily basis and also involves outsourced services.
A very clear example of operational expenditure are online music subscriptions, in which the user pays a monthly fee and has access to a library with different songs. The service remains active as long as payment is made, being interrupted in your absence.
It is worth noting that operating expenses are tax deductible in the same year of their realization. In addition, it is important to manage these expenses well in order to try to reduce them without harming the quality and level of production.
Examples of disbursements related to this category include:
- maintenance and repairs;
- license fees;
- publicity;
- lawyers’ fees;
- office expenses;
- safe;
- property taxes and administration;
- expenses with vehicles, travel, leases, raw materials and payroll.
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Differences between CAPEX, OPEX and TCO
Total cost of ownership (total cost of ownership) is a method of comparing direct and indirect costs over time. It makes an assessment of these expenses and identifies the real value of the item and what is necessary to maintain its functioning.
Due to its concept, TCO is often confused with capital and operational expenditure. To be clearer, see the following example: you have an event company and many places do not have the necessary electricity, which requires a generator. The purchase of this item is a capital expense.
However, the generator will consume labor for its operation, maintenance parts, lubricants, fuel and transportation to the site. In this case, we have the TCO, which is the amount disbursed for the equipment to work. Finally, operational expenditure exists when you choose to rent the item.
How to calculate each index?
Accounting for capital and operational expenditure varies. The rules for the calculation are:
CAPEX
The first step is to analyze the changes that occur annually in the assets. For example: if your company’s balance sheet identified R $ 1 million in assets in 2016 and R $ 2 million in the following year, the change was R $ 1 million.
Likewise, changes in liabilities should be accounted for, considering the period of 1 year. Again, the balance sheet is used for this calculation. If it shows R $ 500 thousand in 2016 and R $ 1 million in 2017, the change was R $ 500 thousand.
Then, just subtract the change year by year to arrive at the capital expenditure itself. In a simple formula, we have that: CAPEX = change in assets – change in liabilities. This calculation is relevant because it refers to an investment cost that increases the possibility of the company generating a profit.
OPEX
This calculation is simpler, because it consists of the sum of operating expenses over a given period of time, usually 1 year. Due to its characteristic, this accounting becomes an alternative for the company to achieve cost reduction and increase in productivity.
Among the positive points of this analysis are:
- maintenance of the cash value with the consequent use of the budget for another purpose, without the need for decapitalization;
- increased cost flexibility;
- decrease in the need for financing, as they are diluted over time.
Keep in mind that the hiring of the operational expenditure has the purpose of making a different payment method regarding the aggregated services. In addition, this act must have the guarantee that the company has all the necessary resources, including monitoring, technical assistance and implementation.
Difference calculation
A common situation is that the company has to calculate the difference between the two indices. In this case, care must be taken not to incur a common error: that of multiplying the monthly amount disbursed by the service and comparing it to the value of the equipment.
In this calculation, indirect costs are ignored, which considerably interfere in the operation. Thus, when making a high-value initial investment in order to grow in the medium term, it should be considered that the revenue will only emerge a long time after the expense. With this, the company will often have to deal with cash flow.
Realize that in a situation like this, the infrastructure is developed based on a growth perspective. Thus, the organization still has an idle capacity until it reaches what it expects. For example: the company made an investment in hardware and, consequently, energy. The return will be long term, so it is necessary to make an estimate that tends to vary according to different factors.
Regarding IT, it is still necessary to consider that the average depreciation period for equipment varies from 3 to 5 years. In that time it is necessary to spend on the renewal of licenses, expansion of the update, possibility of discontinuing the technology and prerequisites for the security of the equipment. Therefore, it is necessary to count the labor of analysts, technicians and support staff.
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CAPEX vs. OPEX: what is the difference in practice?
In this article we have already presented the two concepts and the difference between them. However, in practice it can be a little more confusing. Therefore, we elaborate the following example: imagine that your company has a well designed project and with good expectation of return. The duration is 12 months.
The main cost of this project is related to the labor and maintenance of the machines, which are operational expenses. However, to start it, it was necessary to acquire a new room and more equipment for the hired employees. These are capital expenditures and, therefore, are fixed and immediately impact the financial part.
Operating expenditure expenses are variable, because it is impossible to know when it will be necessary to maintain equipment or repair the room. It is evident, then, that operating expenses are continuously managed and have a shifting component.
To better understand, it is necessary to analyze each aspect separately:
OPEX
This index can bring capital savings to the organization, mainly because it is possible to make the tax deductibility of the expense. This is the case with outsourced services. For example: it will be necessary to purchase new computers for a given project. The cost of purchasing the machines is R $ 45 thousand. However, it is possible to rent the equipment at a reduced price and which includes maintenance.
Is this amount included in the company’s balance sheet as a cost or expense? In the second case, it is deductible from the calculation of the real profit, which reduces the total taxes paid and helps to maintain the company’s financial health.
Another relevant issue is that all items purchased for your business depreciate, but this does not happen with operational expenditure, because the products are renewed as soon as the contract is finalized. After all, it is an outsourced service that disregards technological lag costs.
The advantage is that your company maintains its capital and the amount can be used for another purpose. On the other hand, contracts tend to be long-term, which requires more planning.
CAPEX
In this case, the investment is employed in business operations. Depreciation occurs according to the forecast of duration. The resources are more significant and can decapitalize – at least partially – the company, which means that other disbursements could be jeopardized.
This is because the company will need to purchase the equipment and still take care of maintenance and labor. The benefit for the company is that it becomes possible to buy or improve fixed assets, that is, the tangible assets required for organizational functioning. In addition, the useful life of the items extends beyond the year in which the investment or purchase occurred.
Realize that the fixed assets represent the effective of the company’s equity. These items are analyzed to define the company’s market value. Therefore, capital expenditure brings more representativeness to the organization and, with that, it can raise its market share for standing out from the competition.
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Which methodology should you choose?
This is a difficult question to be answered, because it requires consideration of the current scenario of the company and the peculiarities of the project. It is necessary to adjust and know the company’s expenses based on an in-depth knowledge of capital expenditures.
A very common situation is that companies are limited in relation to the total capital expenditure to which they can have access, either by private creditors or by the market. The restriction of this type of investment occurs mainly when there is a financial crisis in the market.
Thus, organizations tend to direct investments towards activities that generate revenue. Therefore, there tends to be a greater preference for rent or outsourcing instead of buying, because this is a way to avoid capital immobilization.
A simple example of this situation is the adoption of the Infrastructure as a Service (IaaS) format. In this model, the entire business infrastructure is inserted in the hybrid cloud – or in common, but the first is more secure – and the resources are paid in full as a service, not as a product.
One of the transformations provided by this model is the elimination of servers locations, which are now operated in the cloud. The benefits of this practice are greater scalability, easier maintenance, reduced costs, and increased portability and flexibility. It is also important to note that in IaaS, capital expenditures become operational, because they refer to cloud services.
Thus, it is evident that the differences between capital and operational expenditure are many. Therefore, the choice for your business must fall based on the assessment of how each expense fits into the growth objectives and goals projected for the company.
To facilitate your analysis, it is worth paying attention to 3 essential points for your choice:
- ability to execute the project with / without fixed assets, in order to define whether it is possible to use third party services or whether investments are mandatory;
- projection of project costs, revenues and expenses, including taxes and expenses for manufacturing, purchasing or providing services and operating expenses. The aim is to assess the ability to generate profits by comparing these items;
- forecast of the duration of the investment made. At this point, it is worth questioning what the company’s organizational goal is, because revenue can come a long time after the expense and this requires greater care with cash flow.
These 3 points are interconnected when you make an assessment based on cost and revenue data, as well as your projections. In this way, it is possible to quantify the Net Present Value (NPV) and the Internal Rate of Return (IRR) for both capital and operational expenditure.
Finally, it is necessary to consider the payback (return on investment) of each of the alternatives. In general, the advantages of opting for operating expenses are the total investment of money in the company’s operations and the consequent increase in market value. On the other hand, there are more financial charges and the opportunity cost of the invested capital, which tends to request a quick return, although this is not always possible.
With operational expenditure, however, there is no investment, but there are disbursements. The positive side is that the company saves, because it only pays for the time it uses the item and there is still a deduction of expenses. The negative is that this practice can cause an increase in expenses that could be paid for the purchase of the product or service over time.
In summary, the factors that should be considered in your choice are:
- cash flow;
- operating, opportunity and financial costs;
- fiscal savings;
- contractual bonds;
- project life cycle.
For this, it is recommended to carry out an assessment of the capital structure, market requirements for each type of organization, indebtedness, venture risk, capital immobilization, tax situation and relationship with suppliers. In practice, the impacts of the modalities occur in relation to:
- equity: capital expenditure immobilizes assets and operational recognizes them during the project;
- cash flow: capital expenditures have a significant outflow and can add the opportunity cost of invested capital. The operational ones represent a monthly disbursement;
- profit: capital expenditure shows higher profit, because operational impacts the periodic results;
- tax savings: operating expenses are deductible and have greater representativeness in relation to depreciation and opportunity cost when compared to capital expenditure.
The care that must be taken when making this choice is to link the data to the Earnings Before Interest, Taxes, Depreciation and Amortization indicator, or Profit Before Interest, Taxes, Depreciation and Amortization. But what is EBITDA? This index assesses how much the company generates with its operating activities, disregarding financial investments, taxes and loans. In other words, it evaluates the operational cash generation.
In addition, the EBITDA analysis allows us to assess organizational efficiency and competitiveness, mainly in the annual comparison and with the competition. Precisely for this reason, the addition of capital expenditure to that indicator in the calculation of free cash flow is an error because it raises the indicator artificially.
Keep in mind that operating expenses should always be seen as investment outlays and, therefore, are subtracted from EBITDA. By committing this failure, you will erroneously calculate the fair value, which can influence your choice and make your company lose money and opportunities.
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The choice for IT
The Information Technology sector has a difference in relation to other departments of the company. For demanding a infrastructure very large and there is a possibility of cloud computing, operational expenditure becomes important for some features.
THE migration for the cloud requires less purchase of traditional hardware and software, which reduces investments in physical assets. Among the advantages obtained with this practice are the absence of depreciation of the capital asset, since the machines are out of date and / or underutilized in a short period of time.
Realize that not all systems will operate at maximum capacity on a daily basis, as there is seasonality, which brings idle on some days of the month. Thus, operational expenditure does away with this issue, since IT assets are better allocated and used. Resources are also shared based on the idea of optimization, which leads to a reduction in infrastructure maintenance costs.
Finally, there is even more agility to increase IT capacity and meet business demand. After all, scalability and elasticity are characteristics of the cloud. In any case, it is always necessary to analyze the impacts and risks that the company runs. This is how you will have a well-designed strategy to increase your project’s chance of success.
As you can see, there is no magic formula. It depends a lot on the situation of the company and the project, but the objective is always the same: to guarantee concrete results and with the lowest possible risk. Therefore, it is impossible to analyze the numbers separately. It is recommended to consider the advantages and expenses with the greatest impact on the investment. That way, you will arrive at the most appropriate answer.
Remember also to focus on adding value and enhancing benefits, situations resulting from the adoption of an appropriation of expenses and an appropriate investment model.
Now that you understand the differences between CAPEX and OPEX, just apply the concepts to each project started. You can also subscribe to our newsletter and get other tips relevant to your business directly in your email.
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