When it comes to spending money on new equipment, software, and other assets for your business, you’ve got two options: you can either obtain them as a capital expense (CapEx), or as an operating expense (OpEx).
Here’s a scenario for you.
Let’s say you have purchased a company car. This is great as it will be yours to drive forever. You will write a check for it, and write it off as an operational expense (gas, repairs, mileage – OpEx expense.) But, what if you live in New York, where the price of a garage is more than a home, then it would make sense to use Uber to get around, instead of owning a car. You will write it off as a business-related expense – OpEx.
Gartner Says Global IT Spending will total of $3.7 trillion by the end of 2018, an increase of 6.2 percent from the prior year. For this reason, it deserves new consideration. Which is better for my business, and are both a viable option?
Let’s explore these options further.
Capital expenditures (CapEx) are the money a company spends on fixed assets. Things like the improvements of a building, a vehicle, equipment, and land. These one-time purchases stick with a company for more than a year, and show up on the balance sheet, while the cost depreciates over time. Finance teams and bookkeepers applaud these CapEx tax depreciations.
Operating expenses (OpEx) are used to run day-to-day operations. Things like printers and scanners, air conditioners and paper, electricity, and other supplies. These are pay-as-you-go items that show up on a on the company’s statement, and are deducted from income as they occur.
In many cases, companies prefer to lease equipment instead of buying it outright, and therefore choose CapEx, since the money doesn’t have to be paid upfront – instead, it can be deducted. Undoubtedly, deducting expenses reduces income tax.
Capex is useful when it comes to equipment—something that’s more mechanical than technological, as it will be here for years. Technology, on the other hand, will depreciate over time. For an architecture or interior design firm, for example, the need to purchase real estate, or for a solar or HVAC company, CapEx is more useful.
Many companies think that OpEx is better than CapEx. Is this true?
It is a common myth that buying IT infrastructure is better than renting it. It is said that you can save money and have fewer headaches with an Operating expenditure expense versus a Capital expenditure investment.
If you are a start-up, and growing, and want to maximize cash flow, then an Operation expenditure approach is a good fit. For example, small companies often lease a cloud-based email service and pay a smaller monthly bill, rather than upfront for an ERP.
Analysts, however, say that a CapEx investment strategy is best most of the time. Let’s say you are an established company, a profitable business – you should be CapEx-focused. Why? Purchasing a piece of capital equipment is better as you will keep it over a longer time period.
Accounting in Capex and Opex
CapEx and OpEx is handled differently for accounting purposes. Capital expenditures are recorded as assets on the profit/loss statement, while Operating expenditures are recorded as expenses. The costs incurred through a Capital expenditure are not deducted in the period they was incurred. And, as tangible assets depreciate, while intangible assets are amortized, cost is spread out in different financial periods.
Businesses are increasingly under pressure to wisely spend their capital budgets by making the correct decisions on what to buy and when to replace equipment. A trade-off occurs. Should existing equipment be replaced or upgraded? Should technology be bought or leased? These questions give companies a competitive edge over the competition.
One size doesn’t fit all, however. Yet, there are persuasive reasons to turning CapEx into OpEx. Reaping savings and pulling the plug if an expensive project won’t materialize means there is more security with Operational expenditure.
If you want to maintain your competitive edge and stay relevant in your industry, you should understand that a key part of that is being innovative. If you are an industrial and commercial equipment provider, the evolution from CapEx equipment sales to Product-as-a-Service is invariably the next evolution in the way business is often conducted by forward-thinking companies.