Capex is a contraction of the term capital expenditure, and refers to the expenditures made by a business to add new fixed assets, replace old fixed assets, and pay for their ongoing maintenance. The success of some businesses may depend on making large capex investments over a long period of time, to build their capacity.
The level of capex required to operate a business varies dramatically by industry. For example, a professional services business, such as a tax accountant, may not have any capex at all. Conversely, an oil shipment business must invest enormous sums in pipelines, tankers, and storage facilities, so capex comprises a large part of its annual expenditures.
The acquisition of a capex item generally requires a formal analysis and approval by management, with more expensive items possibly even requiring the approval of the board of directors. This analysis typically includes a review of the discounted cash flows associated with a requested capex expenditure; an alternative is to base the investment decision on the impact of the expenditure on the constrained resource of a business.
The accounting for capex varies, depending upon the nature of the asset. The two alternatives are:
- Asset treatment. If an expenditure is greater than the capitalization limit of a business, and is for an asset whose utility will be used up over a period of time, then record it as a fixed asset and depreciate it over the useful life of the asset.
- Expense treatment. If an expenditure is less than the capitalization limit or the result only maintains an asset in its current condition, then charge it to expense as incurred.
Outside analysts may track the level of capex reported by a company from year to year, to see if it is investing a sufficient amount to maintain company operations. This analysis is not always accurate, for the following reasons:
- Step costs. A company may have needed to buy an unusually large capex item, such as an entire production facility, which it will not have to duplicate in every subsequent year. Thus, the capex trend line tends to be lumpy.
- Acquisitions and disposals. Larger companies may routinely buy and sell subsidiaries, along with their fixed assets. A high level of churn makes it difficult to ascertain the true amount of annual capex of the parent company.