Understanding Capital Expense vs. Operating Expense | Capex vs. Opex

Today, we are going to take a good look at your business’s expenses – namely, understanding capital expense vs operating expense. Commonly referred to as “capex” and “opex,” both costs are critical in how well your business performs and operates.

When you clearly understand what each of these means to your budget, you will have an easier time streamlining your spending and improving your company as a whole. 

Capex vs. Opex

Capex

Both are related to the money that you pay out in your business ventures. However, the similarities end there, as they function in completely unique and different ways. Short for Capital Expense or Capital Expenditure, capex is the expenses that your business incurs as it works toward creating benefits for the future.

A good example of capex is if your company invests in new and improved equipment. The idea is to increase production or improve the customer experience so that you can wait on more people at one time.

This would be an investment that is designed to improve operations in an attempt to bring in more revenue. And as a small business owner, more revenue is the name of the game. While new equipment and machinery is an expense in the here and now, the hope is that it eventually pays for itself several times over in the future. That’s capex.

However, it doesn’t start and stop with just upgrades. It can also apply to fixing equipment or making repairs around your store. Anything that can help your operations in the long run is likely to fall into the category of “capex.”

When you work capex into your budget, it should reflect how much you are regularly spending as you attempt to build for the future. It isn’t uncommon for business analysts to take a keen interest in capex among different companies, as it helps to determine where the focus is, why it’s there, and how it can help in the long run. 

Since a business’s capital expenses can vary wildly each year, it is important for business owners to factor in capex over a certain amount of time. You wouldn’t want to set aside the same amount of money when budgeting for capex since it can easily take on many different forms and needs.

What your appropriate capital expenditure should be will likely be vastly different from the next business owner. It largely depends on what type of business you’re in and the nature of your industry. 

Opex

Simply put, this is the money that it takes to keep your business alive. There are no benefits involved in these expenses other than keeping your lights on and your doors open. Short for Operational Expenditure or Operating Expense, opex entails a litany of costs associated with running a company.

These are things like rent, employee wages, utility bills, and so on. As you can see, you aren’t going to expect any return on these expenses – just the necessary costs of running a business. 

Your company’s opex may be needed for other things, too, like making repairs around your business. This type of maintenance is necessary, as failing to do so can lead to the disrepair of your building and ultimately result in you getting shut down.

Since there are no benefits of the future to be had in spending operating expenses, opex indeed gives you a clear financial understanding of what it takes to run a business. 

There is certainly a fine balance to the right operating expenditure. A company that pays way too much in operating costs can find themselves struggling to stay alive, especially if sales are down. A successful business needs to make sure well ahead of time that their revenue will comfortably pay for their operating costs.

In a much larger business, such as a big-block retail giant, this typically isn’t an issue. But for a small business startup, this could be a challenging roadblock to overcome, especially if it hasn’t been open long enough to establish clientele. Many new business owners have been forced to close their doors for this very reason. 

COVID-19 and Opex

To give you a real-world example that most people can relate to, look around your local town at the small businesses. It is very likely that many of them have been forced to shut down at the hands of the pandemic. 

Why now? Because they simply aren’t getting the business that they used to. And in some states, they are ordered to keep their stores closed, forcing them to shut down permanently

The operating cost is simply way too high to sustain when you aren’t getting customers. Since rent can’t be paid as a result, small business owners everywhere are having to consider other options for supporting their families. 

Capex, of course, doesn’t even apply here since there is nothing to build toward under the current conditions. As you can see, there’s a very thin line here in relation to operating expense and shutting down. 

Capex, Opex, and Accounting

Further differences between capex and opex lie in their accounting methods. When you’re trying to factor capex into your income statement, you must remember that capex uses money that reaches far beyond the tax year.

After all, capex is designed to build for the future; thus its assets will continue to be put to use and therefore can’t be deducted – at least, not during the year that they were incurred. However, they can be amortized or depreciated.

Opex, on the other hand, can be deducted without issue. Whenever you calculate your profits and losses (if any), you will need to subtract your operating expenses from your revenue.

Which is Better?

For the most part, businesses prefer opex. This is because capex is used for machinery and equipment – investments for the future. Opex, however, will often be used to lease items and equipment from vendors that aren’t needed on a daily basis. 

Any time that a business leases from a vendor, it is considered a normal part of daily operations. This allows the company to deduct it at the end of the year, as we discussed above. The practice of deducting business expenses helps to reduce the amount of income tax that a company pays, as it is levied on the net income.

Take Control of Your Expenses

If you look at your business’s yearly budget, you are sure to find that a considerable amount of it is reserved for capex and opex. It is understandable, then, that business owners try to drastically reduce one over the other. 

While this may sound like a solid plan on paper, you might want to consider finding a balance between the two. Reducing either of these expenses in favor of another could prove to be damaging to your business. How, you ask?

Think about it this way: You significantly scale back your operating expenses in the hopes of reducing costs, but then something breaks later on down the road. Without the necessary budget to repair your problem, you could find your performance and sales suffering as a result.

If you run a grocery store and your freezers fail, for example, it could set you back considerably while you wait to gather the funding to make the needed repairs. These are things that you can’t always foresee, but with a steady budget in effect, you can be better prepared for tomorrow.

When you are in control of your expenses, you will be far less likely to experience downtime when something breaks or when sales are slow. Taking a proactive approach to managing your capital and operating expenses will give you the upper hand in streamlining your business.

Summary

If you are a relatively new small business startup, it is important that you not get discouraged over your expenses. It takes plenty of time to learn how to balance both your capex and opex. There are business owners who have been doing this for years who still struggle with these aspects.

If you are one of the many who has been affected by COVID-19, we understand how challenging it must be trying to sustain your small business. You might want to consider looking into a small business loan if you haven’t already. Many people just like you have relied on loans to get them through during this troubling time in our economy. 

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We invite you to explore the rest of our blogs. You will find additional information and direction on how best to run your business during the pandemic, as well as tips for improving your chances of getting a loan, and much more.

We hope that they provide some guidance in your journey to growing your small business. Please feel free to contact us if you need assistance securing funding for your business. We look forward to working with you.

 

Sources

https://www.thebalancesmb.com/capital-expenses-defined-and-explained-398153

https://www.accountingtools.com/articles/what-are-examples-of-operating-expenses.html

https://www.cnbc.com/2020/09/16/yelp-data-shows-60percent-of-business-closures-due-to-the-coronavirus-pandemic-are-now-permanent.html

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