CapEx vs. OpEx – A Primer from Middle-Aged Man

CapEx vs. OpEx – A Primer from Middle-Aged Man

SNL_0660_09_Middle_Aged_Man

Back in the day, there were a series of skits on Saturday Night Live called “Middle-Aged Man.” It featured Mike Meyers, as a middle-aged dude who’s superpowers were things like understanding how to jump start a car, knowing where all of his appliance warranties were, and understanding what “Escrow” actually meant.

Having to learn what “CapEx” and “OpEx” are doesn’t automatically mean you’ll become Middle-Aged Man Person. But it may mean the difference between being able to effectively chart a strategic, sustainable spending plan for your department, area, or business – and leaving money on the table, or – worse – squandering opportunity.

First: some definitions.

CapEx, or capital expenditure, is a business expense incurred to create future benefit (i.e., acquisition of assets that will have a useful life beyond the tax year). For example, a business might buy new assets, like buildings, machinery, or equipment, or it might upgrade existing facilities so their value as an asset increases.

OpEx, or operational expenditure, is the money the business spends in order to turn inventory into throughput. Operating expenses also include depreciation of plants and machinery which are used in the production process.

Source: Diffen.com

Seems straightforward enough. But… so what? Why does this even matter to me?

Well, it matters because understanding the differences between these two methods of expenses separates the acolytes from the masters.

Consider it this way –

OpEx is typically what most of us think about when we hear the word “budgets.” OpEx represents costs like payroll, materials, what we pay vendors, healthcare costs, benefits. Essentially, the cost of doing business. It’s like writing checks out of your bank account; living within your means.

CapEx, on the other hand, is supposed to be for “out of band”, long-term spending projects. Typically, these are supposed to be strategic, and far lasting in nature. Capital expenditures are typically paid out of cash reserves, or issuing bond debt, or drawing upon a line of credit. In effect, this type of spending is like getting a second mortgage on your house, or using your credit card to make purchases (I’ll revisit the differences in capital spending funding methods in a future post).

Problems in keeping your spending priorities in order (and expenditures types clearly defined and separated) usually begin to creep in when your revenue stream is disrupted; you have a drop off in incoming cash, or an unanticipated drop in customers, or the economy simply tanks beneath you. Your costs don’t go away, and you’re now challenged with “keeping the doors open” or “coasting through the downturn.”

The first knee-jerk reaction might be to blindly start chopping away at costs, battening down the hatches, counting the paper clips.

Or, shudder the thought , moving critical OpEx expenditures into the CapEx column (Danger! Danger, Will Robinson!).

But this is the corporate equivalent of buying Pizza for lunch, by drawing on your home’s second mortgage – you’re paying for that Pizza over the next thirty years, rather than at the end of the month with your paycheck. Not smart.

Look – I’m not saying that you should never move OpEx spending over to CapEx. Sometimes, you must, because it literally means the very survival of your business (which is also one of your first early warning signs that the biz is in serious doo-doo, like buying groceries with your credit cards rather than your paycheck). The most immediate danger in treating true operational expenditures as capital expenditures, is that it masks the actual costs of what it takes to run your operation, so that you can no longer clearly and transparently gauge – or report – how well your business unit is really doing. But, more than that, this is simply not a sustainable model of operations. You won’t be able to fund your operations indefinitely this way.

Because there will always be a day of reckoning.

Whenever I take on a new assignment involving annual spending budgets, one of the first action items I undertake is to make sure that OpEx items are all properly accounted for, where they need to be accounted for: compensation, contracts, materials. Then, I look at the identified CapEx accounts, to make sure that there aren’t any hidden line items there, masking themselves as long-term assets when they’re actually short term (and usually, variable) liabilities.

Again – why does this matter?

Because: with CapEx expenditures, they are long lasting by nature and by definition, and usually can’t be simply wiped away with drastic austerity measures. You have to earn your way out of them – or default upon them. That’s it.

With your OpEx liabilities, you can cut back on production, reduce your work force, decrease your spending – in short, this is where you can make a significant difference in your balance sheet with some level of immediacy.

And people still wonder why more folks don’t want to get into an administrative position.

Understanding what CapEx and OpEx can mean for your company, and your effectiveness as an administrator, isn’t sexy in the least.

But it will make you a grown up.

Just ask Middle-Aged Man.

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