Comparing Operating Expenses and Capital Expenses

All businesses, from self-employed freelancers to Fortune 500 corporations, spend money. You might have to pay rent, buy inventory, pay employees, buy a desk lamp, or purchase heavy machinery—or even a new building. These expenses lower your company’s overall profit margin, so it’s critical to pay close attention to how you’re spending money.

Not all expenses are considered the same in the small business world. Some expenses, like rent and wages, are regular and recurring. Generally, these everyday purchases are considered operating expenses. Others, like the purchase of a vehicle or property, happen once and then last your business a long time. These are known as capital expenses.

The terminology can be misleading—if you drive it every day, isn’t a new car an operating expense? Probably not. Knowing the nuances of operating expenses and capital expenses is important for every small business owner.

Furthermore, differentiating between the 2 categories becomes paramount when preparing financial statements and filing your business taxes.

Operating Expenses

Operating expenses, often abbreviated to OPEX, are expenses incurred during the course of regular business—your operations, as it were. These include general and administrative expenses as well as the cost of goods sold (COGS). On your profit and loss statement, these expenses are recorded in the same time period they were actually incurred.

The list of operating expenses is vast and ever-expanding—office supplies, equipment leases, travel, some types of taxes, utilities, and insurance are all considered operating expenses because you spend the money in order to conduct regular business. Wages are operating expenses, although they might be calculated into your COGS depending on your business.

Capital Expenses

Capital expenses, or CAPEX, are expenses that a business incurs that are expected to remain valuable beyond the current year. You might use collateral or take on debt to make a capital expenditure. The point of spending on CAPEX is that the expense now will help your business to expand over time—so a CAPEX should be seen as an investment.

Property, equipment, and vehicles are common capital expenses. Expanding or adding value to an existing asset, like through a building expansion, could also be a CAPEX.

Instead of recording capital expenditure on your profit and loss statement, you list CAPEX as assets on your balance sheet.

Importantly, many capital expenses—like vehicles—depreciate in value over the usable lifespan of the asset. This depreciation over a fixed period of time, usually monthly, is recorded as an expense on your profit and loss statement. Overall depreciation is recorded on your balance sheet and subtracted from the value of the asset.

While many CAPEX are tangible entities, like buildings, some intangible purchases can be considered CAPEX, particularly patents.

Why Are OPEX and CAPEX Categorized Differently?

OPEX and CAPEX are considered different in accounting terms because operating expenses are necessary to your business’s day-to-day existence, while capital expenses are big, 1-time expenses that will add value to your company for years.

Sometimes you can choose how you want to categorize an expense. If you buy a car outright, for example, it’s a CAPEX, but a lease for a vehicle is an OPEX.

OPEX vs. CAPEX on Financial Statements

Categorizing OPEX and CAPEX on your financial documentation is a strong reason to have an accountant overseeing your books. Additionally, most CAPEX will require input from other stakeholders in your business because of the size of the expense.

“While OPEX are line items in the expense category on a cash flow statement, CAPEX are typically found under the heading ‘Investment in property, plant, or equipment,’” e-commerce company Shopify explains. “CAPEX usually require a sizable financial investment and, for that reason, often need the approval of the company’s board of directors or shareholders.”

Categorizing your various expenses on the proper profit and loss statements and balance sheets is essential for understanding the overall financial health of your company—and will better position you to receive funding.

OPEX vs. CAPEX During Tax Time

Not categorizing your expenses correctly with the Internal Revenue Service can result in penalties or even an audit. Even in less extreme cases, you can end up paying more in taxes if you aren’t separating your expenses as well as calculating the depreciation of your CAPEX.  

“Through depreciation you recover the cost of the asset over its useful life,” says Manny Davis of AllBusiness. “The IRS has strict requirements as to how many years an asset must be depreciated over. Since these assets cannot be expensed 100% in the tax year they are purchased, it will lead to a higher taxable income amount for the company in the given year and therefore higher taxes.”

The IRS allows some CAPEX to be expensed in total and at once through Section 179. Because of specific situations like this, you should consult with a tax professional about your business taxes—even if you don’t regularly hire an accountant. Utilizing bookkeeping software like Lendio’s software also helps.

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