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Capital Expenditures: Definition, Formula & Examples

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  • 0:00 What is Capital Expenditure?
  • 0:48 Balance Sheet and Fixed Assets
  • 1:43 Key Formulas
  • 2:25 Example
  • 3:15 Lesson Summary
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Lesson Transcript
Instructor: Kimberly Winston
Businesses often make purchases that help them to maintain or grow their current operations. This is called capital expenditure. In this lesson, you will learn what capital expenditure is and examine its formula as well as some examples of it.

What Is Capital Expenditure?

Why does anyone buy new furniture? Generally, it is bought to improve the overall look and feel of your home. Most people are not going to purchase new furniture on a monthly basis or even on a yearly basis. Purchasing furniture is not a regular household expense.

When businesses purchase physical items that enhance or maintain their performance, but are not regular everyday expenses, this expense falls under the category of a capital expenditure. It is also known as a capital expense, or CAPEX. Capital expenditures do one of two things: they either help to upgrade the existing business, or they promote growth, such as the purchase of a new business.

Balance Sheet and Fixed Assets

You can find information about a business' capital expenditure on its balance sheet. Typically, it will be shown in the section labeled fixed assets or, sometimes, long-term assets or non-current assets. A fixed asset is an accounting term that refers to a physical asset that cannot readily be converted to cash. This would include things like office furniture, property, or equipment.

Let's say you bought a house that cost $250,000. Most people would not pay for it all at once. The cost of it would be spread out over a specific period of time. Businesses do the same thing with capital expenditures. In accounting, this is called capitalization. What this means is that the cost of the physical asset is spread out over its useful life. The balance sheet also shows the asset's depreciation. This may be defined as a decrease in the asset's value over time.

Key Formulas

In order to calculate a business's capital expenditure, you would need the balance sheet for the years you are interested in.

Capital expenditure = purchase of new fixed assets + upgrades to existing fixed assets - sale of any fixed assets during the accounting period

It is also helpful to understand how depreciation is calculated. There are several ways that depreciation may be calculated. However, this lesson will only discuss the straight line depreciation method, because it is the simplest.

Annual Depreciation = Capital Expenditure / Life (in years)

Example

Capital expenditure varies depending on the business and the industry. Some businesses, like an oil refinery, would require large capital expenditures for things such as a plant and equipment. However, capital expenditure is required for most businesses. Let's look at an example.

Sally owns a daycare business. She has decided to purchase new commercial grade playground equipment. The playground equipment cost is $40,000. It costs $2,500 for the equipment to be delivered and $1,000 for it to be set up. Sally expects that the playground equipment will last 7 years before it needs to be replaced. Sally's balance sheet would show the $43,500 cost of the playground equipment depreciated over 7 years.

Lesson Summary

Let's review. Capital expenditure is any money a business spends to upgrade or grow their business. It can also be referred to as a capital expense, or CAPEX. There are two types of capital expenditures:

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