Money spent on plants and equipment represents capital expenditures.
Companies spend a lot of money on a lot of things, but each expense usually falls into one of two categories: operating expenditures and capital expenditures. The difference boils down to day-to-day expenses vs. long-term investment. Because these expenditures are handled differently in accounting and under the tax code, most companies maintain separate capital budget and operating budgets.
Types of Expenditures
A capital expenditure is money spent to acquire an asset that adds value to the company. In other words, capital expenses are investments. When a company buys a building, for example, or a piece of equipment, that's a capital expenditure. An operational expenditure, on the other hand, is money spent to run the company day to day. Workers' salaries, for example, are operational expenses. Within the business world, these concepts are often abbreviated as CapEx for capital expenditures and OpEx for operational expenditures.
Example
Say a company needs a copy machine. The cost of the machine itself is a capital expense. Once purchased, the copier goes on the company's balance sheet as an asset, meaning that when it comes time to add up the total value of the company, that value increases by whatever the copier is worth. The costs of the electricity to run the copier and of the paper and toner that go into making copies are operating expenses. On the balance sheet, operating expenses are essentially liabilities, as the overall value of the company is reduced by the amount owed for operating expenses.
Making a Choice
Some expenses can be either capital or operational, depending on how a company wants to handle them. Bernard Golden of "CIO," a magazine for corporate executives who oversee information technology, uses the example of a data-storage center. A company could buy a group of computer servers to handle its data and then put up a building to house them. In that case, the data center would be a capital expense, and the costs of running it would be operational. Or it could rent space on servers maintained by a separate company. In that case, the data center would be entirely an operational expense.
Tax Treatment
The U.S. tax system treats capital and operating expenses differently. Operating expenses are generally deductible from a company's taxable income in the year the expenses are paid. Capital expenses, on the other hand, must be "capitalized," meaning a company must spread out the deduction over several years. This reflects the way companies usually treat capital expenses in their own accounting -- as a cost spread out over the life of the asset, not taken all at once.
Tags: operating expenses, capital expenditures, value company, balance sheet, capital expenditure, capital expense