CapEx vs. OpEx
However involved you are in corporate accounting, you’ve probably heard the terms capital expenditure (CapEx) and operating expenditure (OpEx) floating around. These two types of expenses have significant ramifications for businesses in all industries as they purchase a variety of items.
CapEx and OpEx are two different ways for companies to spend money and get the products and assets that they need to keep things moving every day. Both appear on a balance sheet in different ways and can influence your cash flow. To help you better understand them, we’ve put together a guide on capital expenses and operating expenses and how they can influence your cloud services model.
What Is CapEx (Capital Expenditures)?
A capital expenditure is one that a company makes to purchase significant goods or services that will be used for more than a year. These expenses depreciate over time, signifying the amount of use the item goes through. That’s part of why a car with 100,000 miles on it is worth less than the same car with no miles on it.
Depreciation puts a numerical value to that use, and it is particularly high for electronics. Say a company buys a piece of equipment. As they use it day after day, the asset becomes less valuable. The amount of depreciation can then be deducted on a tax return.
On the property, plant and equipment (PP&E) section of the balance sheet, CapEx purchases are listed as assets. They also get included in a cash flow statement as investing activities.
The needs of a company’s industry will dictate what its capital expenditures look like. Some common ones include:
- Equipment purchases and upgrades
- Real estate purchases
- Building improvements or expansion
- Vehicle purchases
- Hardware purchases
What Is OpEx (Operating Expenditures)?
Operating expenditures, on the other hand, are spent to keep the company running every day. These ongoing expenses, like rent and salaries, are often monthly or recurring. They usually make up the largest portion of costs for a business and are commonly the place where management tries to cut costs. The trick is to do so without negatively impacting the company’s ability to create its product.
These operating expenditures can be fully deducted for the tax year they are purchased in, making it a benefit in some scenarios. Many companies choose to lease a product instead of purchasing it if they want to classify it as an operating expense and reap the tax benefits. Doing so can help a company boost its cash flow by allowing it to deduct the total cost of the item in that year, and not spread out over multiple years with depreciation involved.
Some examples of operating expenditures include:
- Raw materials
- Licensing fees
- Consumables like office supplies
- Property taxes
- Any expense under selling, general and administrative expense (SG&A) on an income statement
What Are the Benefits of Each?
Different businesses typically find that either CapEx or OpEx works better for them in general, since you can only identify most items as one or the other. Typically, OpEx is the preferred expense approach because of its impact on tax season. Of course, the CapEx vs. OpEx debate is full of advantages and disadvantages.
The Case for OpEx
OpEx offers more immediate tax deduction benefits. Businesses can write off their purchases in the year they are made instead of spreading them out over several tax years. This reduces the income tax they must pay and puts more money in the bank. The extra money can grant the company more earning power since it can be used right away to generate more revenue.
Many businesses, especially those that are new or don’t have much cash flow yet, benefit from this faster tax break. It often factors into decisions to lease or purchase monthly service options instead of investing in expensive equipment. For example, a growing business with limited cash flow might benefit from the increase in cash that comes from writing off a product in the year it is purchased with OpEx. Instead of buying the product and going through depreciation, they could lease it and deduct it from taxes in the immediate year.
Another bonus to OpEx is that it doesn’t require extensive upfront investments. Typically, with leasing or monthly access options, you can spread the cost out into more manageable installments. This aspect is again helpful for businesses with less excess cash.
The Case for CapEx
Of course, CapEx has its benefits too. It tends to be more useful to large, established businesses due to its long-term nature. CapEx adds to a company’s assets. While a small part of the purchase gets deducted in the accounting year in which it is purchased, the bulk of it is spread out and doesn’t save the company much money on taxes. Still, the asset is 100 percent owned by the company and looks good on your balance sheet before it depreciates.
CapEx can offer a company more control over the asset. Many services that are traditionally CapEx can be turned into OpEx, like software access and data storage. Instead of purchasing software or hardware, companies can pay for access to these services.
How Do They Relate to Cloud Computing?
The rise of cloud computing and Software as a Service (SaaS) has created the option for IT to be considered OpEx rather than CapEx. The traditional approach might be to purchase your hardware outright. That can be a significant expense which would then lose value in the coming years. Nowadays, many companies choose to lease their IT equipment, which turns it into an OpEx.
Different types of cloud computing will play into this equation.
- Public clouds: Public clouds tend to be the easiest route for businesses looking to take advantage of an OpEx model. In a public cloud, the service provider manages the cloud, and users pay as they go. Typically, the cloud servers are located off-site and cared for by the provider. They will usually have a full staff of IT experts dedicated to keeping your service uninterrupted.
- Private clouds: In a conventional private cloud approach, an organization uses CapEx to purchase server hardware, which would then depreciate over the next few years but would be owned by them. These servers are usually on-site and maintained by the company, but third-party IT services can also help with maintenance. Sometimes, other entities within the company can use CapEx resources with an OpEx model.
- Hybrid clouds: A hybrid cloud can combine elements of both public and private clouds to suit the needs of the individual business. You may be able to more appropriately manage costs as needed with certain components that match your requirements.
CapEx purchases in the world of cloud computing often entail large components, like network-attached servers or databases. Other items that might factor into an OpEx vs. CapEx decision include:
- Operational costs: The hardware itself is only part of the equation. When running a server, you’ll also need to consider the cost of powering the equipment and cooling it. And if you don’t happen to have a spare room, you might be paying to store it, as well.
- Variance in data usage: If your data use goes through spikes and periods of low use, you might over- or under-utilize your setup. A server system with more power than needed could cost you resources, while one with not enough power can interrupt your workflow and frustrate customers and employees. Cloud service is scalable and can offer systems that grow and shrink with your need for data, so you can meet demand like that in seasonal spikes.
- Upgrades and maintenance: When you own your system, your IT team is in charge of upgrading and maintaining the system. OpEx cloud services generally bundle these costs with your regular charges.
The CapEx vs. OpEx Cloud Computing Debate
When it comes to CapEx and OpEx, which one is the better solution? Each option provides different benefits and drawbacks, so selecting the right one depends on the industry and the unique business making the purchase. Still, there are many factors that influence how IT professionals and accountants determine the best approach to cloud computing.
Calculating the best approach isn’t simply a matter of comparing a list of pros and cons. It often requires detailed calculations of regular use, depreciation, rental costs, varied usage and other aspects that will influence the cost of the item. That means that accurately forecasting your data needs can be a valuable skill.
Here are a few of the factors that go into the CapEx vs. OpEx in the public cloud debate.
1. Avoiding a Large Investment
Renting or leasing equipment removes the burden of a long-term investment. You don’t have to worry about its loss of value or how you’re going to get the highest return on investment (ROI) possible. That burden is taken on by the service provider.
For that benefit though, you typically pay more for your short-term use than you would if you owned the product and spread out the cost of ownership over that period. However, that short-term use ends up being less expensive than ownership once you consider other factors. That’s why people are happy to pay for rental cars instead of purchasing a new one for a two-week trip.
Many companies would rather have the money that they would have invested in hardware in their pockets, to use toward revenue-boosting projects. An OpEx model offers that. On the other hand, ownership and a high-value asset might be more important to some businesses.
2. Depreciation Schedule
Technology usually runs on three- and five-year schedules. If a product has a useful life of three years, its value will drop by a third each year. After three years, it won’t be worth anything on a balance sheet, but might still be functional and vital to the operation. So where does that value go? It transfers into operating costs, and depreciation becomes an OpEx, hitting your bottom line.
With an OpEx service model, depreciation is irrelevant. The responsibility of that, and recouping the investment, falls to the service provider.
3. Added Operating Costs
When you own your hardware in a CapEx model, you’ll also have to factor in other costs of operation. For example, if you own a server system and hard drives, you’ll also have to pay for the power, IT help, and cooling mechanisms. And that doesn’t include any costs for space. If you don’t have an extra room to devote to server space, you may have to expand or rent more room. In an OpEx model, these expenses are included with your cost.
4. One-Time Purchase vs. Recurring Payments
If your contact with the service provider is difficult and frustrating, you likely won’t want to repeatedly work with them. On the other hand, an easy-to-work-with provider can make the process more appealing. Some companies like the idea of not working with anyone else, which can make ownership more attractive, even if it is more expensive.
With so much work involved in setup, you typically want to set it and forget it. But financially, this isn’t always best. Instead, the application should respond to demands in usage. Many times, financial analysts assume full-time peak loads to calculate need, which wouldn’t accurately reflect the cost savings of a more efficient model that adjusts to meet requirements. To support this approach, well-managed cloud environments readily adjust to peaks and valleys in usage and can maximize value while retaining minimal setup procedures.
5. Level of Control
Typically, there is no third party involved with cloud services in CapEx. It allows the company to make changes as needed and add any features they deem necessary, such as extra security or backups.
This higher level of control can also be seen as a disadvantage for other companies. They may not have a robust IT team to handle upkeep and maintenance, or they might not want to mess with any of those details. It depends on the business and its preferences.
Another reason that leaving more control to a service provider can help is due to scalability. If you find out that you have more data than hard drive space, adding more can be a costly and time-consuming mission. Cloud service providers can scale your service up or down as needed.
Choosing CapEx or OpEx
If you need to decide between CapEx and OpEx approaches, there is a lot to consider. Cost, of course, is the primary factor. But you’ll also want to think about what else each of these options offers you and how that will affect your work. Would updated technology from a cloud service provider improve the work you do? Does your company have the budget and organization to manage an on-site system with its own IT department?
Asking questions like these can help you identify other areas where CapEx and OpEx can offer financial benefits and what kind of aspects your company has to work with. Also consider how well you can predict your company’s data needs in the future — this needs to be spot on if you’re using CapEx. OpEx approaches can be much more forgiving if your estimates turn out to be incorrect since you can change your agreement accordingly.
Spend some time considering your business needs and how well you can adapt the advantages and disadvantages of each option.
Our Cloud Services and Resources
If, like many businesses throughout New York, you find that an OpEx model would suit your budget best, we offer cloud services and other resources to help out. Our cloud services can provide convenient monthly storage with comprehensive safety assessments and around-the-clock server monitoring.
We also offer:
- Managed IT services: Our experts become your on-call tech team, ready to help with a variety of problems as they appear.
- Unified communications: Integrate your voice, video and data communications under one umbrella for ease of use and cost savings.
- Network solutions: Let us create custom network solutions efficiently designed for your business needs.
To learn how Consolidated Technologies, Inc. can help you meet your OpEx goals, reach out to an expert today.