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  • Writer's pictureGarrett Stuart

What is Capital Expenditure? (CAPEX)

Updated: Mar 20

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If you’re in the midst of starting a new business, you’ll be looking at the major investments that you’ll need to make to help scale your business to where you want it to be. Capital expenditure is one of the things you need to consider, and you, and your accountant will need to take this into account both now, and in the future. Let’s take a dive into capital expenditure, what it means, and why you need to be aware of it for your business.

What is capital expenditure?

Capital expenditure is the term that accountants and tax bodies use to refer to the money that businesses spend on major physical goods, or services that will be used for longer than a year. They may be referred to by the business as a business asset. It can be a premises for the business to run from, a piece of equipment or a vehicle that constitutes a major investment, especially if they are necessary for everyday use, or to transport goods or equipment. Purchases that can be classified as capital expenditure will differ between businesses and certainly between different industries.

How are everyday expenses different from capital expenditure?

Everyday expenses are often referred to as operating expenditures, and they are the expenses that businesses make in order for the business to run effectively. Everyday expenses can include bills such as rent, electricity, and water, as well as salaries and pensions, if they are applicable. Research and development costs, taxes, and travel costs such as fuel can be counted as everyday expenses too.

Operating costs will be the majority of outgoings for most businesses, which is why management teams will look at the ways that they can reduce them, without having an impact on the effectiveness of the business. Most operating expenses are tax deductible in the year they are made, but there are occasional exceptions – and if you’re not sure, you should always check with your accountant.

Who needs to be involved in a capital expenditure decision?

There’s no one-size-fits-all answer to this question, since there are so many variables from business to business! Capital expenditure is a major financial investment, requiring cash or credit to be used, and so businesses shouldn’t make the decision lightly. In many cases, there are several stakeholders that should be included in the decision. These may include the board of directors, shareholders, and so on.

What is capital budgeting?

If you think this sounds like planning your capital expenditure, you’d be correct. Capital budgeting is often used to identify those long term investments that a business needs to make, as well as the flow of money going in and out of the business. Of course, businesses should always be budgeting, but there are some limitations to capital budgeting.

Advantages of capital budgeting include:

  • Being able to understand risk and the effects on the business

  • Making informed decisions

  • There are multiple ways to assess and understand capital budgeting

  • Capital budgeting can potentially help realise greater profits

  • It can allow greater control over the amount of expenditure required

  • Prevention of over- or under- investing in the business

There are some downsides to capital budgeting though, including:

  • Once capital budgeting decisions are made, they are usually irreversible

  • Where there is uncertainty, decisions may not lead to the desired outcome

  • The amount of risk that is perceived is subjective

  • Getting the right professionals to assist you can be tricky, with additional cost

  • Capital budgeting can be expensive

Despite these limitations, capital budgeting is essential for any businesses that are considering investing in capital expenditure. It allows all the relevant parties to clearly understand the pros and cons of their investment, and to ensure the return on investment is clear, including whether the purchase will help to increase the value of the company. Capital budgeting should help all those involved in purchase decisions to make the best choice, particularly when there are multiple options on the table.

What are capital allowances?

Capital allowances can be claimed in the UK for certain capital expenditure, either by the business, or by the accountant working on behalf of the business. Examples of capital expenditure listed by His Majesty’s Revenue and Customs (HMRC) include:

  • Equipment

  • Machinery

  • Business vehicles

  • Renovating business premises (in certain areas of the UK)

  • Extracting minerals

  • Research and development

  • ‘Know-how’ (intellectual property about industrial techniques)

  • Patents

  • Dredging

  • Structure and buildings

If you’re looking at making a major purchase for your business, it is always advisable to speak with you accountant, or a tax professional before you go ahead. They will be able to ensure that your purchase is made in the most tax-efficient manner.

Exceptions to claiming capital allowances

While claiming capital allowances is a good idea for many businesses, it isn’t always the best approach for all. Sole traders and partnerships that earn up to £150,000 per annum may find it better to use cash for purchases. Where this is the case and capital allowances have been claimed, there are steps that can be taken. If you’ve authorised them as an agent with HMRC, your accountant can complete these steps for you.

If your business is in the first year of operation, the full cost of your capital expenditures may be deductible from before-tax profits, in addition to the annual investment allowance. In the first year a business exists, some additional ‘enhanced capital allowances’ can be applied to certain purchases that allow businesses to operate more efficiently. Examples include:

  • Certain cars that have low CO2 emissions

  • Energy saving equipment is on the energy technology product list. This includes certain motors

  • Some water saving equipment. Check the water efficient technologies product list for more details

  • Types of plant and machinery for gas refuelling stations. This can include storage tanks and pumps

  • Certain types of gas, biogas and hydrogen refuelling equipment

  • New zero-emission goods vehicles

As always, there are exceptions. In this case, they include assets that are being purchased to be leased to other people, and where the asset is for use in a home that is let out by the company. If these apply, you probably won’t be able to claim on those purchases.

How to claim your capital allowances

When you’ve established the capital allowances that you’re planning on claiming, you can do so by completing:

  • A Self Assessment tax return (if you’re a sole trader)

  • Partnership tax return (if your business is a partnership and you are a partner)

  • Company tax return (if you’re a limited company – be sure to include a capital allowance calculation separately)

Employees making major purchases for business should claim tax relief separately. You can find more about claiming tax relief on expenses here.

You can claim the full value of the purchases as part of your annual investment allowance, or your first year allowance. You will need to do this in the correct accounting period, based on when you made the purchase. It is also possible to claim part of the value, using writing down allowances. This is permitted at any time, as long as you own the item.

The useful life of a capital expenditure purchase

Most major assets, such as vehicles, are subject to depreciation, which is the wear and tear incurred as the item is used. When maintenance and servicing costs become too high, the item will need to be replaced, but the useful life of a capital expenditure asset will differ from item to item. It may be that a capital expenditure item lasts five or ten years, but if the purchase is property, then depreciation may be calculated over more than twenty years. Your accountant will calculate depreciation on capital expenditure assets for you.

What happens when you no longer use an asset?

If a business sells a capital expenditure purchase – maybe they decide to sell a business premises, for example – then the accountant records it in the accounts as cash flow from investment activities.

If the capital expenditure asset is at the end of the useful life, then it may be possible to recover some cash by selling it for salvage, or for repurposing parts, such as in the case of vehicles. Where the asset has become obsolete – where the item is outdated and no longer suited to manufacturing processes, for example – then it may need to be completely scrapped, which may result in the company not receiving a payment.

Whichever the outcome for the asset when it is no longer used, it is written off the balance sheet completely.

Our final thoughts

Capital expenditure is one of the biggest investments to be made in a business, and most successful businesses will need to make those purchases sooner or later. The advantages of making capital expenditure purchases in the first year of business can influence the decision as to whether you invest now, or later. Our key takeaways about capital expenditure:

  • Capital expenditure refers to the major purchases for a business, not your daily expenditure

  • All relevant decision parties in a business should be included in capital budgeting, so that the best decision can be made

  • You should carefully understand HMRC rules about capital allowances to be sure of the optimal outcomes

  • Depreciation and end of life disposal should be considered when making a capital expenditure purchase

If you’re a small business that is just getting off the starting blocks, capital expenditure might not have crossed your mind as yet. But if you’ve planned well, and have the right business support – such as a great accountant – helping you, then you may get there sooner than you think. Planning ahead for your capital expenditure will help you do so most efficiently.


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