Difference between Capital Expenditure and Revenue Expenditure

Capital expenditure and revenue expenditure are both important for any business to operate smoothly. However, the cost incurred serves different purposes. While capital expenditure creates more assets, revenue expenditure aids day-to-day operations of a business.

In this article, we will be discussing the difference between capital expenditure and revenue expenditure. We will also learn about the features and drawbacks of these two types of expenditures. 

Table of Contents

• Difference Between Capital Expenditure and Revenue Expenditure
• What is Capital Expenditure(CapEx)?
• How are long-term assets acquired via capital expenditure?
• Features of Capital Expenditure
• Limitations of CapEX
• What is Revenue Expenditure (OPEX)?
• Features of Revenue Expenditure
• Limitations of OPEX

Difference between Capital Expenditure and Revenue Expenditure

The difference between Capital expenditure and revenue expenditure is as shown below:

What is Capital Expenditure (CapEx)?

Capital expenditure (CapEx or Capital Expenses) refers to the funds that are used by companies to acquire, maintain and upgrade their physical assets. This expenditure for goods and services is capitalised on the balance sheet instead of being expensed on the income statement of the company. Purchasing property, vehicles, and heavy machinery is a part of capital expenditure. There are two forms of the CapEx including expenses to maintain the levels of operation that are present within the company and expenses to enable the increase in future growth.

Through CapEx, one can understand how a company invests in its existing and new fixed assets for the purpose of business growth. To capitalise on an asset, the company has to spread the cost of expenditure over the useful life of the asset. Capital expenditures can be traced in the cash flow from the investing activities within the cash flow statement of the company. Experts can calculate capital expenditure using financial data from financial statements, including balance sheet and income statement.

Capital expenditures can be calculated using the following formula:

CapEx = ΔPP&E + Current Depreciation

ΔPP&E=Changes in property, plant, and equipment​

How are Long-Term Assets Acquired Through Capital Expenditure?

Long-term assets are acquired through capital expenditure: 

• Identify asset needs by assessing current assets and planning for improvements.
• Create a budget, including costs like purchase, installation, and legal fees.
• Seek approval based on ROI and alignment with strategic goals.
• Secure funds for the project, either internally or through external sources.
• Execute the project by purchasing or upgrading assets and performing installations.
• Record the CapEx as an asset on the balance sheet and depreciate it over time.
• Expect long-term benefits, such as improved efficiency and increased revenue.
• Regularly monitor and maintain assets to ensure optimal performance.
• Assess ROI and make necessary adjustments to strategies through reporting and analysis.

Types of Capital Expenditure (CapEx)

Capital expenditures are those type of funds that are used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment. CapEx can also include investment in intangible assets. The types of capital expenditures include:

1. Property, Plant, and Equipment (PP&E):

• Land and Buildings: Costs associated with purchasing land and constructing buildings.
• Machinery and Equipment: Costs to acquire production machinery, computers, and office equipment.
• Vehicles: Costs for purchasing transportation assets for company use.

1. Improvement Costs:

• Upgrades to existing assets that extend their useful life or improve efficiency.
• Costs to adapt existing assets to new uses.

1. Intangible Assets:

• Patents, licenses, and trademarks.
• Software development costs.
• Goodwill from acquisitions.

Features of Capital Expenditures

CapEx has the following significant features:

1. Capital expenditure has long term impacts on the future business activities of the company.
2. These expenditures are irreversible in nature and will incur losses on reversal. 
3. CapEx is very expensive for the manufacturing, telecom and oil industry.
4. They first increase in the assets accounts and then undergo continuous depreciation throughout the useful lives of the asset. 

Explore free investing and markets courses

Limitations of Capital Expenditures

There are some disadvantages associated with capital expenditures:

1. The process of identifying and measuring the expenditure cost is complicated. 
2. The outcomes of capital expenditure are not predictable in nature and are predictable to losses. It is important to consider potential losses to better forecast the outcome. 
3. Due to their long term benefits, capital expenditures are stretched over a long period of time. This causes issues in discount rate estimation and establishment of equivalence. 

What is Revenue Expenditure?

Revenue expenditure (operating expense or OPEX) refers to the expenses that do not add to asset creation. These expenses are incurred on business operations during the production of goods and services. In a given period of accounting, these expenditures are important for generating revenue. These are the expenditures incurred for maintaining operational activities and managing assets. 

However, these do not boost the profit-generating capacity of the business. There can be direct and indirect expenses. Direct expenses include shipping charges, freight charges, direct wages, commission, rent, legal expenses and utility bills. Indirect expenses include taxes, salaries, interest, depreciation and other expenses occurring from repetitive administrative operations. 

Explore free operations courses

Features of Revenue Expenditures

The following are the features of revenue expenditures for any company:

• Operating expenses have short-term benefits that do not extend beyond one accounting period. 
• It is applicable for tax deduction in one accounting period due to its recurrent nature. 
• Through revenue expenditure, companies can identify the areas that require improvement or change for better business operations. 
• It is used for measuring the stocks of the company and cost management competency.
• Company can perform horizontal analysis to understand its current financial situation. 

Types of Revenue Expediture (OpEx):

Revenue expenditures are short-term expenses that are incurred during the normal course of business, and they are used to manage day-to-day operations. They are fully expensed in the accounting period in which they are incurred. The types of revenue expenditures include:

1. Operating Costs:

• Payments for using facilities and services.
• Employee compensation.

2. Maintenance and Repairs: Regular maintenance and repairs of assets to keep them in working condition.

3. Sales and Marketing:

• Advertising and promotional materials.
• Sales activities and customer acquisition costs.

4. Office Supplies and Consumables: Stationery, software subscriptions, and other consumables used in daily operations.

5. General Administrative Costs: Office expenses, insurance, and legal fees.

Disadvantages of Revenue Expenditure

Revenue expenditure has a few disadvantages for the business:

1. It is an add-on cost that the business has to bear without any benefit in the future. 
2. Revenue expenditure can only portray the current financial situation of the company, which means it cannot provide the accurate financial standing of the company. 
3. The benefits of revenue expenditure are limited to a single accounting period which limits the long-term benefits. 

Conclusion

The main difference between capital expenditure and revenue expenditure is the time period for which these are applicable. These two expenditures also differ in their returns to the business. While these two differ in their purposes, both are essential to operate and grow any business.