OPEX and CAPEX: managing the balance between expenditure

Day-to-day payments and major investments are two complementary areas of expenditure in a company’s operations, yet they must be managed in different ways. OPEX, CAPEX: for some, maintaining a balance between these “Yin and Yang” of cash flow management can be a real challenge.

Would you like to get to grips with the challenges posed by these two areas of expenditure? Follow our guide!

Understanding OPEX

Definition

OPEX, an English-language abbreviation for “Operational Expenditures”, refers to the operating costs associated with a product, a system, but also, and above all, a company. The introduction of this term helps to better understand and visualise a company’s cost structure.

In practical terms, operating expenses represent the most day-to-day costs and offer the most direct return on investment. These expenses are essential to the smooth running of a business and are necessary to ensure its steady growth.

Operational expenses can be divided into two sub-categories:

Selling, general and administrative expenses (SG&A) are the day-to-day costs necessary for the operation and growth of the business:

• human resources: staff salaries and social security contributions (accounting, marketing, IT, administration, etc.);
• development costs: marketing and advertising budgets, as well as monthly loan repayments;
• property costs: rent, insurance.

Cost of goods sold (COGS) refers to the costs associated with the sale of goods or services:

• material resources: raw materials, components;
• energy resources: water, gas, electricity;
• logistics costs: travel, business trips, deliveries.

Please note: The majority of operating expenses can be described as consumable in the sense that they do not represent a long-term investment. Operating expenses are therefore generally paid and “consumed” within the same accounting period.

In terms of cash flow management, prioritising operating expenditure helps to smooth cash flows and thus (provided it is managed effectively) optimise working capital requirements (WCR).

Understanding CAPEX

Definition

Unlike operating expenses (OPEX), capital expenditure (CAPEX) refers to investment expenditure and is therefore more focused on the company’s long-term growth.

Capital expenditure has a significant impact on working capital requirements, as it generally represents a substantial financial commitment whose return on investment (ROI) can only be realised gradually, over a period of several months or years.

CAPEX can refer to various types of investment, for example:

• the purchase of vehicles;
• the purchase of IT equipment (computers);
• the purchase of production equipment (machine tools);
• equipment optimisation.

A company’s shareholders keep a close eye on capital expenditure, as this reflects longer-term growth prospects and may therefore signal a gradual increase in profits and dividends.

Good to know: Capital expenditure can be financed either internally (using the company’s own funds) or through other means, such as debt or crowdfunding.

Hidden costs

Although CAPEX represents a one-off (and usually substantial) investment, it would be wrong to assume that the purchase is the only source of expenditure. 

In fact, a capital expenditure often entails additional costs associated with its maintenance, such as:

• utilities (electricity, air conditioning);
• storage (lost revenue due to the space used);
• technical maintenance (cleaning, updating).

To complement the many factors to consider when making a capital expenditure, it is advisable to estimate how frequently the CAPEX will be used. This will make it easier to calculate the ROI and help determine when the investment will break even.

OPEX or CAPEX: every company’s dilemma

The issues

Both OPEX and CAPEX represent two complementary categories that are essential for the maintenance (OPEX) and growth (CAPEX) of a business. It is therefore clear that striking the right balance between these two types of expenditure is a key challenge for any company.

Because these expenditures are the cornerstones of wealth creation, any measures taken to optimise your cash flow management will have a significant impact on your strategic decisions regarding OPEX and CAPEX.

Whilst capital expenditure is sometimes unavoidable in many industrial sectors that rely on heavy machinery, the dilemma is far more complex when it comes to making decisions in the IT sector.

“Is it better to outsource a recurring task to a service provider (OPEX) or to invest in the necessary equipment in-house (CAPEX)?” This is the sort of question many companies regularly find themselves asking.

It should be noted that the growth of Software as a Service (SaaS) and cloud solutions is further expanding the range of possibilities and, by extension, the uncertainties.

In any case, the fundamental issue remains the same: how can we strike a balance between short-term and long-term expenditure?

Choose according to the context

Depending on the company’s financial health and sector, greater emphasis will be placed on one or the other of these categories of expenditure. Overall, a situation of financial instability (whether due to internal factors or a global economic crisis) will result in higher operating expenses (OPEX).

Because they occur regularly, OPEX costs are more predictable and therefore make it easier to draw up longer-term financial plans.

Furthermore, in order to spread the cost of investment in a new venture (premises, business mergers, etc.), many business leaders are turning to operating expenditure (OPEX) by spreading the cost of expenses over a monthly basis (rent, loans, etc.).

As such, capital expenditure (CAPEX) is generally envisaged in a context of growth and economic prosperity for the company. Without such prospects for the future, operating expenditure (OPEX) will offer greater security.

Decision-making

It is during the annual budget-setting process (usually in the autumn of year N-1) that decisions are made regarding the choice between OPEX and CAPEX.

To make this process easier, it is important to have a clear understanding of each expenditure, in particular by identifying its nature and the objectives it serves. 

As experience is gained over time, company-specific rules can be drawn up to support, or even automate, decision-making for each item of expenditure.

Operating expenses and capital expenditure therefore represent, in their own way, the sources of your company’s costs.