CAPEX v OPEX: A tale of two budgets

Best practice

CAPEX v OPEX: A tale of two budgets

Cloud is great and solves a lot of problems – but it can also cause some new ones too. Back in my days as a reseller, whenever I spoke about cloud, I’d often find myself in a conversation about CAPEX v OPEX and I soon learned that the way you pay for cloud can be as big a factor as what you use it for. Some organisations had a strong preference for one method over another for various reasons, some that could have an impact on a company’s financial reports at the end of the financial year. This meant, and still does, that the way software is licensed and purchased can have a big impact on the company overall – and vice versa.

We hear a lot about these two budget types, but I thought a quick overview of what they are and some of the differences between them could be useful.

CAPEX

The CAPital EXpenditure budget is generally used for big purchases of goods or services that will be used for more than 1 (one) year and create benefits for the business. This can include things like:

• Factory equipment
• Buildings
• Computer hardware
• Perpetual software

And these are recorded as assets to the business on the balance sheet. The cost of the asset is then depreciated over a set number of years (typically 5 to 10) to represent that just a portion of its value to the company is realised each year.

As an example, if you buy some servers for £100,000 you might depreciate them over 10 years at £10,000 per annum; this depreciation amount is then deducted from the annual tax return.

OPEX

The OPerating EXpenditure budget is for day-to-day costs that keep a business running, things like:

• Rent
• Utilities
• Travel
• Subscription software

And OPEX expenses are recorded in full as expenses in the period in which they’re made – so not written down over the following years. That said, pre-paying for multiple years of a subscription may be recorded as a “pre-paid expense” – this is somewhere in-between CAPEX and OPEX, so it can be written off over the course of the subscription agreement.

Why does this matter?

OPEX spend can help businesses reduce their income tax bill but, as all the money is spent at once, it reduces the EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) and may cause an organisation to look less profitable than if it purchased software from its CAPEX budget. Equally, as purchasing via CAPEX adds assets to a company, that can make them look more attractive and show higher earnings for investors.

The realities of accounting for software are very complex – depending on all manner of factors including region specific tax laws, company focus, length of terms, usage periods, type of software, and more. That said, it may be worth working with your finance and accounting teams to understand if changes to your software purchasing methods can have a positive impact on your overall financial position – be it tax, cashflow, balance sheet etc.

Further Reading

Differences between the budgets

Prepaid Expenses

EBITDA

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