‘Control your expenses better than your competition. This is where you can always find the competitive advantage.’
Sam Walton, founder of Walmart (10 Rules for Building a Business)
In a nutshell
Opex (operating expenditure) is money spent in running a business. It is recognised in the profit and loss account.
Capex (capital expenditure) is money spent on ‘long-term (fixed) assets’. It is recognised in the balance sheet.
Need to know 
The key differences between opex and capex are shown in the table below:
| Opex | Capex |
|---|---|
Definition Expenses incurred in running a business. Also referred to as revenue expenditure. | Definition Payments to purchase or improve long-term assets. |
Examples Salaries, administration costs, marketing, utilities, repairs and maintenance. | Examples Buildings, machines, cars, computers, office furniture, refurbishments. |
Impact
| Impact
|
Why is this important? 
Both annual profit and the ‘size’ of the balance sheet are important performance measures for both businesses and managers (see Chapter 23 Profitability performance measures and Chapter 26 Long-term solvency performance measures).
The decision to categorise an item of expenditure as either opex or capex will impact the profit and loss account and/or the balance sheet in different ways.
‘Grey areas’
The opex versus capex distinction becomes relevant for items of expenditure which could potentially fall into either opex or capex.
A typical grey area is repairs and refurbishments. General repairs and maintenance are usually opex. Refurbishments are usually capex. There could, however, be repairs or refurbishments which can fall into either category. For example, repairing a broken window could clearly be categorised as opex under ‘repairs and maintenance’. However, if the new window is an improvement on the old window, such as being polarised, then it could be argued that it should be categorised as capex.
When is this important? 
Businesses may be tempted to take advantage of the grey areas and categorise expenditure as capex instead of opex and vice versa when:
- ■rewards are based on profit targets – recognising an expense as capex as opposed to opex will have a favourable impact on the current year’s profits. Similarly, once a profit target has been exceeded, recognising an expense as opex as opposed to capex will reduce the depreciation expense in future years (see Chapter 9 Tangible fixed assets and depreciation)
- ■there are separate organisational budgets for opex and capex and one of the budgets has been fully spent
- ■financing is available for expenditure on ‘investments’ (capex) and not ‘running costs’ (opex).
In practice 
Most companies should have a clear and consistent policy. The same items of expenditure should be treated the same way over time.
However, due to the discretion enabled by the grey areas, different companies could have different policies and show different profits and asset values from the same transaction.
Nice to know 
In practice, companies should use clear and persuasive reasoning to make distinctions between opex and capex classifications. Their decisions should not be motivated by a desire to present target profit and asset values.
To be classified as capex, expenditure should improve a long-term asset and increase its value, rather than merely maintaining the economic benefits expected from the asset.
Accounting standards
There are a number of accounting and financial reporting standards (see Chapter 19 Accounting and financial reporting standards) which cover some common grey areas between opex and capex classification. For example:
- 1Expenditure on development costs is allowed to be capitalised (treated as capex) if a company can demonstrate future benefits from the development.
- 2Certain costs of ‘borrowing’ to purchase a fixed asset can be capitalised.
In practice
To reduce the administration burden, most companies will have a predetermined capex limit. For example, any expense under £1,000, whether a capital item or not, will be ‘expensed’, i.e. treated as opex. Capex requires further record keeping (within a fixed asset register) and depreciation calculations (see Chapter 9 Tangible fixed assets and depreciation).
Optional detail 
In financial statements there is a degree of discretion over opex and capex classification. However, under tax law the distinction between opex and capex is tightly defined. Therefore, the treatment of opex and capex can often be different in the ‘tax accounts’ (essentially a separate profit calculation upon which the tax charge is based) to the financial accounts (see Chapter 8 Business tax).
Reflect and embed your understanding 
- 1The directors of a business are looking to boost the profits reported in the current accounting period. Reflect on your knowledge and understanding of capex and opex and the extent to which this area of accounting might be used by directors to achieve their objectives?
- 2Can you list some examples of grey areas when distinguishing between opex and capex?
- 3What kinds of business decisions could be affected by the classification of opex or capex?
- 4Review the capex policy of an example organisation. Is it clear and unambiguous? If there is a capex limit, is it set at a reasonable level?
- 5Should there be a capex budget and/or target?
- 6How should capex be financed?
For the authors’ reflections on these questions please go to financebook.co.uk
Where to spot in company accounts 
All administration expenses will be opex.
Capex, however, is easier to spot and can usually be spotted in two places:
- 1The fixed asset note(s)
- 2The cash flow statement.
Extract from Greggs plc 2020 annual report and accounts
The intangible assets note can be found on Appendix p. 465.
The property, plant and equipment note can be found on Appendix p. 467.
The statements of cash flows can be found on Appendix p. 449.
An extract from the intangible assets note follows:
| Software £’m | Assets under development £’m | Total £’m | |
|---|---|---|---|
| Additions | 2.7 | 0.1 | 2.8 |
An extract from the property, plant and equipment note follows:
| Land and buildings £’m | Plant and equipment £’m | Fixtures and fittings £’m | Assets under construction £’m | Total £’m | |
|---|---|---|---|---|---|
| Additions | 3.3 | 10.1 | 19.6 | 22.9 | 55.9 |
Extracts from the financial review relating to capex follows:
Capital expenditure
We invested a total of £58.7 million (2019: £86.0 million) in capital expenditure during 2020. The year started with an ambitious programme of investment activity designed to grow our shop numbers and create supply chain capacity for future expansion. In quarter two, in order to protect liquidity, we stopped almost all capital expenditure with the exception of the work on our new, automated cold store at Balliol Park in Newcastle upon Tyne.
As our shops reopened in the middle of 2020 and we became more confident of sustainable trading levels we selectively recommenced capital works. Capital expenditure to support new shop openings was focused on pipeline opportunities in locations which customers typically access by car, these having proved the most resilient under prevailing trading conditions.
Depreciation and amortisation on property, plant and equipment and intangibles in the year was £60.8 million (2019: £59.9 million). A further £51.9 million (2019: £50.8 million) of depreciation was charged in respect of right-of use assets as a result of capitalised leases.
Our plans for 2021 include capital expenditure of around £70 million. This will include completion of the Balliol Park automated cold store, increases to manufacturing capacity for savoury products and a return to the previous rate of expansion of our shop estate. In this respect we will be investing in around 100 new company-managed shops alongside further openings with franchise partners.
Having invested substantially in the shop estate in recent years we intend to refurbish relatively few shops in 2021 but will continue trials of formats designed to support future plans. The requirement for capital expenditure to refurbish our existing shops will increase in the coming years and we will start to address supply chain capacity to meet the growth opportunities ahead. On current plans we expect this to require capital expenditure of c.£90 million in 2022 followed by c.£100 million in 2023.
(Annual Report and Accounts 2020, p. 43)
Consolidate and apply
To see how the concepts covered in this chapter have been applied within Greggs plc, review Chapter 36, p. 386.
Watch out for in practice 
- →Internal discussions about the classification of expenditure as opex or capex.
- →The type and nature of capex and how it aligns to strategy.
- →Year-on-year changes in capex.
- →The ratio of capex to depreciation (see Chapter 9 Tangible fixed assets and depreciation) and amortisation (see Chapter 10 Goodwill and other intangibles).