Defining Capital Expenditure (CAPEX)

various notes of south african currencyCapital Expenditure (CAPEX) Capital expenditure, or CapEx, are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. It is often used to undertake new projects or investments by the firm.

This type of outlay is also made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building, to purchasing a piece of equipment or building a brand-new factory.

The cash flow to capital expenditure ratio, or CF/CapEX, relates to a company’s ability to acquire long term assets using free cash flow. The cash flow to capital expenditures ratio will often fluctuate as businesses go through cycles of large and small capital expenditures.

A high multiple is indicative of relative financial strength. If a company has the financial ability to invest through capital expenditure, it is easier for the company to grow. It is important to note that this is an industry-specific ratio and should only be compared to a ratio derived from another company that has similar CapEx requirements.

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 Capital budgets forecast and spending for capital expenditures (CAPEX), the acquisition of capital assets—usually long-lasting, expensive acquisitions that go onto the company’s balance sheet as assets. On the company’s income statement, capital assets contribute to depreciation expense throughout their depreciable lives.

When deciding which capital investments to make, companies usually use a combination of formal financial criteria, including

  • Net present value (NPV),
  • internal rate of return (IRR),
  • return on investment
  • payback period.

Potential investments are also evaluated with respect to strategic consistency and risk. And, because capital spending is planned to maximize value, investments should be undertaken only when expected returns are equal to or greater than the average cost of capital.

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