OPEX and CAPEX: managing the balance between expenditure

Day-to-day payments and major investments are two complementary areas of spending in the life of a company, yet they need to be managed in different ways. OPEX, CAPEX: for some businesses, maintaining the balance between this “Yin and Yang” of cash management can be a real challenge.

Want to get a better handle on what these two types of spending involve? Read on!

Understanding OPEX

Definition

Short for “Operational Expenditures”, OPEX refers to the operating expenses tied to a product or a system, but above all to a company as a whole. The term makes it easier to understand and visualise a company’s cost structure.

In practical terms, OPEX are the most day-to-day expenses and are the ones recouped most directly. They are necessary for a company to run smoothly and to keep growing steadily.

OPEX can be broken down into two sub-categories:

Selling, general and administrative expenses (SG&A) are the day-to-day expenses a company needs in order to operate and grow:

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

Cost of goods sold (COGS) are the costs directly tied to selling goods or services:

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

Please note: most operating expenses can be described as consumable, in that they do not represent a long-term investment. OPEX are therefore generally paid for, and “consumed”, within the same accounting period.

From a cash management perspective, prioritising operating expenditure helps smooth out cash flows and, provided it is managed effectively, contributes to optimising working capital requirements (WCR).

Understanding CAPEX

Definition

Unlike OPEX, Capital Expenditures (CAPEX) refer to investment spending and are therefore more geared towards a company’s long-term growth.

Capital spending weighs heavily on working capital requirements, since it generally represents a significant financial commitment whose return on investment (ROI) only becomes apparent gradually, after several months or years.

CAPEX can cover various types of investment, for example:

• purchasing vehicles;
• purchasing IT equipment (computers);
• purchasing production equipment (machine tools);
• upgrading equipment.

A company’s shareholders keep a close eye on CAPEX, since it reflects longer-term growth prospects and can therefore signal a gradual rise in profits and dividends.

Good to know: capital spending can be funded either internally, using the company’s own funds, or through other solutions such as debt or crowdfunding.

Hidden costs

While CAPEX represents a one-off (and generally substantial) investment, it would be a mistake to think the purchase itself is the only source of expenditure.

Indeed, capital spending very often brings additional costs needed to maintain it, such as:

• utilities (electricity, air conditioning);
• storage (lost income tied up in the space used);
• technical upkeep (cleaning, updates).

To round out the many factors worth weighing before making a capital expenditure, it is wise to anticipate how often the CAPEX will actually be used. This makes it easier to calculate the ROI and helps pin down the break-even point.

OPEX or CAPEX: every company’s dilemma

What’s at stake

OPEX and CAPEX are two complementary categories, necessary for a company’s upkeep (OPEX) and growth (CAPEX). It’s clear, then, that striking the right balance between these two types of spending is a major issue for any company.

Because these expenses are the pillars of value creation, any lever that helps optimise your cash management will have a major bearing on your strategic decisions between OPEX and CAPEX.

While capital spending is sometimes unavoidable in many industrial sectors that rely on heavy machinery, the dilemma becomes far more complex when it comes to IT.

“Is it better to outsource a recurring task to a service provider (OPEX), or to invest in the equipment needed in-house (CAPEX)?” — this is the kind of question many companies find themselves asking on a regular basis.

Please note: the rise of Software as a Service (SaaS) and cloud solutions is widening the range of options even further — and, by extension, the uncertainty that comes with it.

Either way, the underlying question remains the same: how do you strike a balance between short-term and long-term spending?

Choosing according to context

Depending on a company’s financial health and sector, one type of spending will tend to be favoured over the other. Broadly speaking, financial instability — whether caused by internal factors or a global economic crisis — tends to push companies towards more operating expenditure (OPEX).

Because they recur, OPEX are more predictable, which naturally makes it easier to draw up longer-term financial plans.

What’s more, to cushion the cost of investing in a new structure (premises, company mergers, etc.), many managers turn to OPEX, spreading the cost of the expense out monthly (rent, loan repayments, etc.).

As a result, capital spending (CAPEX) tends to be considered in a context of growth and economic prosperity for the company. Without such prospects, OPEX will offer greater security.

Decision-making

Decisions about whether to go with OPEX or CAPEX are made during the annual budgeting process, generally in the autumn of year N-1.

To make this process easier, it is essential to fully understand each expense, in particular by defining its nature and the objectives it serves.

As experience builds up over time, company-specific rules can be drawn up to support, or even automate, the decision-making process for each type of expenditure.

Operating expenditure and capital expenditure, then, each represent — in their own way — a source of cost for your company.