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Capital expenditure (CapEx) is cash spent on acquiring or improving long-term assets such as property, equipment, or technology.
Capital expenditure (CapEx) represents cash spent to acquire, upgrade, or maintain long-term physical assets such as property, plants, equipment, and technology infrastructure. Unlike operating expenses that are immediately expensed, capital expenditures are capitalised on the balance sheet and depreciated over time. CapEx is essential for maintaining competitiveness but consumes cash that could otherwise go to shareholders.
Types of capital expenditure:
- Maintenance CapEx: Required to maintain existing operations; replacing worn equipment
- Growth CapEx: Discretionary investment to expand capacity or enter new markets
- Regulatory CapEx: Required to meet safety, environmental, or other requirements
Why CapEx matters:
- Free cash flow: FCF = Operating Cash Flow - CapEx; determines cash available to shareholders
- Business sustainability: Underinvestment leads to declining competitiveness
- Growth signal: Rising CapEx often precedes revenue growth
- Capital intensity: High CapEx requirements affect returns on capital
Analysing CapEx:
- CapEx to Revenue: Measures capital intensity; varies widely by industry
- CapEx to Depreciation: Below 1.0 may indicate underinvestment; above 1.0 suggests growth
- CapEx to Operating Cash Flow: Shows how much cash is consumed by reinvestment
Industry capital intensity:
- Utilities: Very high; 20-30% of revenue typical
- Manufacturing: Moderate to high; 5-15% of revenue
- Retail: Moderate; 3-7% of revenue
- Software: Low; 2-5% of revenue (mostly servers/infrastructure)
- Consulting: Very low; minimal physical assets needed
Important considerations:
- Lumpy spending: Major projects create uneven CapEx patterns
- Lease vs. buy: Operating leases shift CapEx off balance sheet
- Acquisition alternative: Companies may buy capacity rather than build it
- Management guidance: Forward CapEx plans indicate strategic priorities
Evaluate CapEx in context. High CapEx isn't inherently bad if it generates adequate returns. Low CapEx may boost near-term free cash flow but risk long-term competitiveness if assets aren't properly maintained.