Capital expenditure

Capital expenditure (capex), is the amount a company spends on buying fixed assets, other than as part of acquisitions.

As this expenditure is an investment it is not immediately shown in the P & L. The amount of cash expenditure is shown in the cash flow statement and the effects of capex obviously show on the balance sheet. Most companies also comment on capex in their results.

It can be difficult to distinguish between maintenance capex (to keep existing operations going at their current levels) and investment made to drive future growth. Investors may be able to infer a certain amount from comments and by looking at a company's circumstances and track record. Capex that is continuously high which has not lead to high growth is likely to be maintenance capex.

Apparent profits or operating cash flows are not actually making shareholders wealthier if high maintenance capex requirements soak up the money. This is why investors should look at measures such as free cash flow.

High capital expenditure is not necessarily a problem: it could be investment that will drive organic growth. Of course not all capex that is claimed to be in growth will actually create growth, so management claims need to be looked at a little sceptically.

Conversely, companies can boost short term cash conversion, by cutting capex. This may even boost medium term profits by reducing depreciation. This is usually a sign of trouble as it implies a low growth or declining business.

Numbers such as ROIC provide measures of how effective past capital expenditure was, but these are subject to various distortions, such as the effect of acquisitions and of accounting conventions such as depreciation. More fundamentally, one needs to consider whether anything has changed, which would make returns on future expenditure from that of past expenditure.

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