What is Capital Expenditure?
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
It takes money to make money. And the money you spend on improving your business and its revenues need to be properly factored into your business accounting.
There is some confusion when it comes to capital expenditure and how it needs to be recorded on the company balance sheet. Many assume that all operational expenses fall under the umbrella of capital expenditure. However, capital expenditure has a different definition to operation or revenue expenditure.
Broadly speaking, capital expenditure encompasses all spending that your company takes on in order to improve or enhance its operations. If it improves your product or service, increases your output or makes your processes more efficient, it likely falls under the definition of a capital expenditure.
Examples of capital expenditure
Capital expenditures, (also known as capital investments) are typically high-cost or high-value items that will be with your business for the long term. These commonly include:
Machinery and plant
New machinery and plant can improve output and facilitate new capabilities. They can improve operational efficiency, enhance production or allow inefficient processes to be replaced. As such, they are classed as capital expenditures.
Software and hardware
Business software and hardware are also essential to the enhancement of your business operations. Replacing hardware such as desktop computers and tablets or upgrading your SaaS solutions all qualify as capital expenditures.
Upgrades to existing assets
Maintenance and repair costs are classed as revenue or operating expenditures. However, upgrades or improvements to existing assets are classed as capital investments because they contribute to the improvement of the business.
As we can see, capital expenses are multifaceted and can help improve your business in a number of ways. This is why it’s important to ensure that your cash flow allows for a capital expenditure budget.
Is capital expenditure the same as operating expenditure?
Both capital and operating expenditure (also known as revenue expenditure) contribute to the running of your business. However, operating expenditures are fundamentally different. Rather than improving or enhancing the business, they simply help to facilitate day-to-day operations.
Operating expenditure may include anything that goes into your Cost of Goods Sold, such as:
- employee wages
- rent or mortgage payments
- business travel costs
- employee catering expenses
It is important to carry out regular cash flow analysis to ensure that the company has sufficient funds for both capital and revenue expenditure.
Learn more about cash flow analysis.
Frequently asked questions about capital expenditure
How do I create a capital expenditure budget?
A capital expenditure budget should certainly be earmarked in your business finances.
These expenses are harder to track or predict than revenue expenses, and they need to be carefully considered so that they don’t disrupt business cash flow. When budgeting for capital expenses, consider:
- rate of return on your capital investments
- how long it will take to see some ROI
- any regulatory and legal requirements
- the opportunity cost of not making the purchase
- any bottlenecking that a purchase may cause for cash flow
What’s the difference between capital expenditure and revenue expenditure
Capital expenditures are fixed long-term costs that contribute towards the enhancement or improvement of your business operations. Revenue/operational expenditures, on the other hand, are the short-term costs involved in maintaining operations and keeping your business functional.
Are capital expenditures tax deductible?
Unlike revenue expenditures, capital expenditures cannot be claimed as deductible expenses. Instead, HMRC allows the deduction of ‘capital allowances’. These provide tax relief for qualifying purchases not exceeding the annual limit determined by HMRC. This limit has been temporarily increased from £200,000 to £1,000,000 from 1 January 2022 to 31 March 2023 for qualifying plant and machinery costs.
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