OPEX vs CAPEX – balancing your spending

Day-to-day payments and significant investments are two complementary areas of expenses in the life of a business, and they need to be managed differently from one another. OPEX and CAPEX: keeping this ‘yin and yang’ of cash management in balance can undoubtedly be challenging.

Do you want to improve how you handle these two types of expenses? Check out our guide!

Understanding OPEX

Definition

Short for ‘Operational Expenses,’ OPEX are the operating expenses that relate to a product, a system, or above all, to a business. The use of the term allows for a better understanding and visualization of the cost structure of a business.

In concrete terms, OPEX are the day-to-day costs with the most direct link to profitability. They are expenses necessary for the smooth functioning of the business to achieve steady growth.

There are two subcategories of OPEX:

Selling, general and administrative expenses (SG&A) are the day-to-day expenses incurred for the business to function and grow:

• Human resources: employee salaries and social security contributions (accounts, marketing, IT, administration, etc.);
• Development costs: marketing & advertising budget and monthly loan repayments;
• Premises: rent and insurance.

Costs of goods sold (COGS) are the costs related to the production of goods or services:

• Materials: raw materials, components;
• Energy: water, gas, electricity;
• Logistics: transportation, business travel, deliveries.

NB: Most operating costs can be classified as consumables because they are not long-term investments. OPEX are generally paid and ‘consumed’ within the same financial year.

In terms of cash management, making operating costs, a priority evens financial flows and so (under effective management) optimises Working Capital Requirements (WCR).

Understanding CAPEX

Definition

Unlike OPEX, Capital Expenditures (CAPEX) relate to investment costs geared more toward the business’s long-term growth.

Capital expenditures take their toll on the WCR balance. They constitute a significant financial commitment with a Return on Investment (ROI), which is only seen gradually after several months or years.

CAPEX can relate to different types of investments, for example:

• Vehicles;
• IT equipment (computers);
• Production equipment (machines and tools);
• Improvements to equipment

Business shareholders keep a watchful eye on CAPEX, as they are a growth indicator over the longer term and can point to a gradual increase in profit and dividends.

Handy tip: Capital expenditure can be financed internally (via private funds) or through loans and crowdfunding.

Hidden costs

Although CAPEX represents occasional (generally significant) investments, it would be wrong to think it only relates to procurement.

There are often associated ongoing costs that come with a capital expense, like:

• Electricity and air conditioning charges;
• Storage (shortfall in space used);
• Technical servicing (cleaning, updating)

It is a good idea to predict the frequency of use of CAPEX so that its many elements can all be taken into account. This makes it easier to calculate ROI and set a profitability threshold date.

OPEX or CAPEX – the business dilemma

The challenges

OPEX and CAPEX are complementary categories, and both are needed for the maintenance (OPEX) and growth (CAPEX) of a business. Therefore, keeping these two expense types balanced is a major challenge for any business.

As the pillars of wealth production, their levers facilitate cash management optimisation and significantly influence the strategic decisions you make between OPEX and CAPEX.

Suppose capital expenditure is sometimes inevitable in many industrial sectors due to a reliance on heavy machinery. In that case, the dilemma is much more complex when it concerns decision-making in the IT sector.

“Is it better to delegate a recurring mission to a service provider (OPEX) or to invest in the necessary hardware internally (CAPEX)?”, this is the kind of question that lots of businesses have to ponder regularly.

NB: The development of Software as a Solution (SaaS) and Cloud solutions has opened up the range of possibilities and – by extension – uncertainties.

The fundamental question remains the same: how should you retain a balance between short-term and long-term expenses?

Choose according to context

The economic health of the business and the sector in which it operates will influence which of these expense types to choose. For example, financial instability (due to internal factors or a global economic crisis) tends towards more significant operating expenses (OPEX).

The recurrent nature of OPEX means they are easier to predict and so facilitate longer-term financial planning.

Many executives opt for OPEX to spread the cost of monthly payments (rent, loans, etc.) to recoup the cost of investing in a new structure (premises, a merger, etc.) 
Capital expenditure (CAPEX) is often framed in the context of a business’s growth and economic prosperity.  OPEX offers greater security where these are not foreseeable.

Making decisions

Decisions between OPEX and CAPEX are made when the annual budget is compiled, usually in the autumn of the previous year.

To facilitate the process, it is necessary to truly understand each expense, particularly defining its nature and the objective it serves.

With time comes experience, and the business rules can be changed to support or even automate decision-making for each expense category.

So in their way, both operating expenses and capital expenditure represent the sources of your company’s costs.