At some point in your business career (hopefully sooner rather than later) you’ll find yourself wondering – what is the difference between capex vs. opex? Whether you want to run a business yourself, understand how a business you work for operates, or advise executives on ways to improve their operations, understanding these terms is a necessity.
Capex and opex may not sound exciting at first glance. Yet, they are critical to managing the profitability and financial position of a business. Buckle up for the most exciting – and useful – discussion of capex vs. opex you’ve ever read.
What Is Capex vs Opex?
First, let’s provide some definitions to ensure we’re all on the same page. Capex refers to Capital Expenditure. What is a capital expenditure (or capital expense)? A business has a capital expense when it purchases assets that will drive value and benefit beyond the year in which they are purchased. Typical capital expenses include plant and equipment purchases, building construction, hardware purchases, and vehicle purchases. An example of this could be a large piece of machinery in a manufacturing plant that is expected to operate for 10+ years.
Opex refers to an Operational Expenditure (sometimes referred to as a revenue expense). A business has an operating expense when it incurs costs to run or operate the business on a day-to-day basis. Typical operating expenses include rent, utilities, salaries, selling, marketing, maintenance and administrative expenses. In the manufacturing example, this would include regular maintenance costs on the large piece of machinery in the manufacturing plant. These costs do not increase the value of the asset and are therefore expensed the year in which they occur.
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Is Capex Better Than Opex For A Business?
This is actually the wrong question to be asking. A healthy business will most likely have both capex and opex. What is better for a business depends on its current growth stage, as well as its organizational goals and financial position.
Classifying an expense as Opex vs. Capex is generally preferable when considering income taxes. Operating expenses are fully realized in the year they are incurred and result in lower profits, and therefore lower taxes payable, in the given year. Another consideration is that operating expenses (and operating leases in particular) may require lower up-front payment, which could be preferable to a company with limited cash.
On the other hand, classifying an investment as Capex vs. Opex could be preferable if a company wants to increase its profitability in the given year. Capitalizing an expense could result in lower costs in the given year, resulting in higher earnings. It would also result in a larger value of assets on the balance sheet.
Is Salary Capex Or Opex?
Because this is a common question, we want to address it directly. Employees’ salaries are typically classified as operating expenses. Individuals certainly add value to a company, but this value is contributed in the given year they are working.
What Is The Difference Between An Expense And A Capital Expenditure?
An expense is classified as a cost to the company in the year it is incurred. It flows through the income statement as an expense immediately and impacts the profitability of the company in the year it is incurred.
A capital expenditure, on the other hand, is treated as an asset that is expensed over several years. Even though the company may have paid for the capital expenditure in cash and all at once, the expenditure is viewed as a long-term asset that should be expensed, for accounting purposes, over the life of the asset. For example, imagine a company spends $1M on a fleet of vehicles that it expects to use for the next 10 years. Since these vehicles will add value and benefit to the company over the long-term, they are capitalized, and therefore placed on the balance sheet, as a $1M asset.
To simplify the example, let’s assume the vehicles will reduce in value at a consistent rate over time. Let's say, $100k per year. In this case, the company would realize a depreciation expense of $100k on its income statement in the first year, and every year after that, until the vehicles are retired.
How Do You Calculate Opex?
Calculating operating expenses is relatively straightforward. Simply sum all the costs a company incurs to run its business on a day to day basis. These costs typically consist of rent, utilities, salaries, selling, marketing, maintenance and administrative expenses.
What Are The Three Types Of Expenditure?
There are three types of expenditure that are generally accepted:
- Capex
- Opex
- Deferred revenue expense.
We’ve already dealt with capex and opex – let’s talk about deferred revenue expense.
This is absolutely a less common type of expense than either capex or opex but is nonetheless important to know. A deferred revenue expense is similar to a prepaid expense. However, while the benefits of a prepaid expense are generally realized in the same accounting period, a fully prepaid expense where the benefits are realized across a number of accounting periods can be classified as a deferred revenue expense. Until this benefit is realized, this expense is classified as an asset on the balance sheet.
Conclusion
Armed with this new understanding of capex vs. opex, you are a more well-informed and well-versed businessperson. You should feel empowered to read and comprehend company financial reports, understand the implications of financial decisions they make, and have more nuanced business conversations with company executives. You’re on your way to conquering the world of business!
Additional Reading:
- Investment Banking Financial Models vs. Consulting Financial Models
- Variable Cost: Examples, Definition, & Formula
- Fixed Cost: Examples, Definition, & Formula
- Business Valuation Methods