Capital expenditures: Overview, definition, and example
What are capital expenditures?
Capital expenditures (CapEx) refer to funds spent by a business or organization on acquiring, upgrading, or maintaining physical assets such as property, equipment, or machinery. These expenditures are intended to improve the company's long-term operational capacity and are typically capitalized, meaning they are recorded as assets on the balance sheet rather than expensed immediately.
For example, purchasing new machinery for a manufacturing plant or investing in a building renovation are considered capital expenditures because they contribute to the company’s long-term asset base.
Why are capital expenditures important?
Capital expenditures are important because they represent significant investments that can drive business growth, improve operational efficiency, and increase future revenue. Proper management of CapEx is crucial for ensuring that a company allocates resources effectively and maintains a strong asset base.
For businesses, capital expenditures often require careful planning and budgeting, as they can have a substantial impact on cash flow and financial health. They are also closely scrutinized by investors and lenders who assess the company’s ability to manage and generate value from its assets.
Understanding capital expenditures through an example
Imagine a company that manufactures consumer electronics decides to purchase new production equipment worth $500,000. This purchase is classified as a capital expenditure because the equipment will be used over several years to enhance the company’s manufacturing capacity. The expenditure is capitalized and depreciated over its useful life, rather than being deducted as an expense in the year it was purchased.
In another example, a retail company renovates its storefront to attract more customers. The cost of the renovation is considered a capital expenditure because it improves the company’s physical asset, the store, and is expected to contribute to long-term business performance.
An example of a capital expenditures clause
Here’s how a capital expenditures clause might look in a contract:
“The Company agrees not to incur any Capital Expenditures in excess of $[Insert Amount] without the prior written consent of the Lender. Any such expenditures must be aligned with the Company’s approved capital budget, which is subject to annual review.”
Conclusion
Capital expenditures are key investments that contribute to the long-term growth and operational capabilities of a business. Properly managing CapEx ensures businesses can maintain and enhance their asset base while effectively planning for future growth.
By including clear provisions for capital expenditures in agreements, businesses can manage their investments responsibly, ensure financial stability, and maintain positive relationships with stakeholders.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.