When analyzing the financial statement of a third party, it may be necessary to calculate the entity's capital expenditures. This is needed to see if the organization is spending a sufficient amount on fixed assets to maintain its operations.
The best approach to calculating capital expenditures is the capital expenditure formula. The steps are:
- Obtain the financial statements of the target company as of the end of the year for the past two years. If the company is publicly-held, this information is readily available on the website of the Securities and Exchange Commission.
- Subtract the net amount of fixed assets listed on the financial statements for the preceding year from the net amount of fixed assets listed for the year just ended. The result is the net change in fixed assets. However, it must be adjusted further with these additional steps:
- Strip out of the calculation all intangible assets. We are assuming that you are only interested in the expenditures for tangible assets, so intangibles are not needed. Besides, most intangible assets were obtained through acquisitions, not through a capital expenditure program.
- Strip out all assets obtained through acquisitions during the reporting period. This information should be listed in the notes accompanying the financial statements.
- Subtract the total amount of accumulated depreciation listed on the financial statements for the preceding year from the total amount of accumulated depreciation listed for the year just ended. The result is the total amount of depreciation for the year just ended. An alternative source is the depreciation expense listed in the income statement for the year just ended. This figure should not include any amortization, nor any depreciation associated with acquired assets.
- Add the total depreciation for the year to the change in the net amount of fixed assets. This is the total amount that the company spent on capital expenditures during the measurement period.
Alternatively, you may be interested in the amount that a company is expending on software development projects. This can be a critical item, if the expenditure is being capitalized instead of being charged to expense as incurred. This information may be disclosed within the fixed assets line item on the balance sheet, or in the accompanying footnotes. In either case, compare the information for the last two years to determine the change in expenditures on capitalized software projects.
An additional question involving capital expenditure analysis is to determine how many of the expenditures are related to the replacement of existing assets, versus expenditures targeted at the expansion of the business. There are three ways to estimate this information:
- Track capital expenditures on a trend line. If expenditures are relatively flat, the bulk of all expenditures are probably of the maintenance variety.
- Compare capital expenditures to sales. There is not a direct relationship with capital expenditures and sales. However, if you compare the two over multiple years, and the proportion of expenditures to sales is rising, it is likely that the company is investing in more than just maintenance capital expenditures.
- Match capital expenditures to business units. If the target company is experiencing rapid growth in a particular business unit, look in the footnotes for the amount of capital expenditures associated with that business unit.