What Does Capital Expenditures (Capex) Mean?
Capital expenditure or capex is the use of corporate funds and/or assumption of liabilities to purchase capital assets that will be used for productive purposes over an extended period of time. This is an outlay made by the firm to maintain or increase the scope of their operations.
Divestopedia Explains Capital Expenditures (Capex)
Capex is an important component in the determination of free cash flows in a business. It has become common place to use EBITDA as a proxy for free cash flows and as the default metric when calculating the enterprise value of a company. EBITDA does not consider capex, and in a capital- intensive business, EBITDA could be considerably different from free cash flows due to the cash investment required for capital equipment.
Using EBIT as a valuation metric partially alleviates some of these issues by deducting depreciation. EBIT may take into account the capital expenditure needs of the business but only if annual depreciation and capex are similar. A hybrid calculation being "EBITDA less future capex" is often used by sophisticated buyers.
When selling a business it is also important to distinguish between:
- "sustaining capex" - capital expenditures required to maintain the existing asset base at their current capacity and condition in order to achieve similar revenue levels; and
- "growth capex" - capital expenditures required to achieve any additional revenue growth and expansion over and above what was reached historically.
The differentiation of sustaining and growth capex is relevant in the preparation of a company's financial forecasts. If future projections show 'hockey stick' growth, then potential buyers will expect to additional growth capex in the forecasts that will reduce future cash flows.
The question that most sophisticated buyers will ask is: Should they pay more for a company's future growth if they have to use their own capital to fund the growth capex required to achieve that growth? In most instances, the answer will be 'no'.