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Capital expenditure is a business term, but do you understand it? Find out what it means.
What is capital expenditure?
Capital expenditure, abbreviated as CAPEX, is any funds used by a company to upgrade or acquire physical assets, including equipment and industrial buildings. It is used to take on new projects or investments in the enterprise. Capital expenditure can also be used by firms to either increase or maintain their scope of operations. In accounting, an expense becomes a capital expenditure when the investment or asset in question is set to improve or improves the life of an existing capital asset.
The amount of capital expenditure depends on the position a company occupies and the type of industry. Oil exploration and production, utility services, and manufacturing usually have the highest levels of capital expenditure.
Equipment upgrade is a common form of capital expenditure. In the manufacturing sector and other industries, machinery might wear out and become obsolete after a considerable amount of working time. When a machine wears out and can no longer be useful, an upgrade becomes necessary.
Buildings and property are typically bought using mortgages and secured debts. Payments for the assets are made over an extended period of time, so there is a need to set aside some capital expenditure from their operating budgets and proceeds. This would ensure that there is no financial deficit that may hinder the process of acquiring property.
Capital expenditure has long-term benefits. Capital expenditure decisions provide the framework for the activities that a firm will be engaged in in the future. As a result, the decisions have a huge bearing on the fundamental characteristics of a business.
Massive production companies’ setups usually involve the outlay of millions of dollars. Capital costs increase with the advancement of technology and the sophistication of the materials used.
Making decisions about capital expenditure can be difficult. Identifying and measuring the benefits and costs of a capital expenditure proposal can be challenging and time-consuming.
The other challenge associated with capital expenditure is that the costs and benefits associated it are usually spread out over long periods of time, sometimes as long as 10 to 20 years, or even 20 to 50 years for industrial and infrastructural projects.
Capital expenditure examples
Software upgrades in successful technology companies usually require regular investments and expansions. Companies often have to expand their computer equipment, including laptop and desktop computers, servers and peripherals. These types of equipment serve a vital role in a company, so it is important to invest in their maintenance and expansion.
Some firms use vehicles to carry out their business. Mining and resource companies require their workers to travel into rural and remote areas and this requires highly dependable vehicles. These vehicles have a relatively high cost. The company may decide to acquire a new fleet, either by buying or leasing. This would mean additional costs to the company.
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