05 August 2013

Capital Expenditure - Fixed Asset Purchase For Long Term Earning Growth

Capex, or Capital Expenditure is part of company's budgeting plan to grow its business. I still remembered that it is up to management's decision to categorize the expenditure under Capex or Opex (Operating Expenditure) and it is recorded under Investing Cash Flow in the Cash Flow Statement. For R&D / Software / Pattern or any other non current assets purchased, it could be categorized under Capex and amortized / depreciated over a longer period, say 5 to 30 years.

So why does the management prefer Capex over Opex? It could be due to several reasons:

  1. A better profit recognized in recent financial report. If you recognize the profit under Opex your net profit margin would be lower. 
  2. The company can capitalize the expenses under Non Current Assets and increase the Total Assets value in balance sheet, and so does the Total Equity value. 
However, for investors who prefer to use Free Cash Flow Method (Operating Cash Flow - Capex), they will take it into consideration and may ask about this question: 
  1. Is Capex growth in tandem with revenue / earning growth? If not, then it may not be a good purchase. 
  2. Is there any trend for a company to start spending money in its investment? I noticed that Japanese company started to spend excess cash pile in R&D activities. I believe this is a good sign for long term revenue growth if the company can provide more products & services to create better services. 
To me, I prefer a net Free Cash Flow (FCF) company. But it means that the company may in mature stage and may not experience exponential growth. For a start-up company, it normally has negative FCF at the beginning until later stage. You may need to consider both Pros & Cons in management's decision in CAPEX before making any investment decision.


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