Capital expenditures, otherwise known as CAPEX, are mentioned in startup board meetings all the time. It’s definitely a fundamental term to understand when dealing with startup accounting.
Capital Expenditures Depend On Your Startup Industry
The importance of your capital expenditures depends a little bit on the type of startup you are running. For example, if you’re a manufacturing or cleantech company, which involves heavy, physical equipment, CAPEX is your number one ingredient in the business.
CAPEX are Investments
At a high level, capital expenditures are investments that a startup makes in things like:
- Fixed assets
- Property
- Equipment
- Computers/Physical Technology
- Furniture
- And, often, software can be CAPEX too
These are big investments. Whether your startup is building robots, or working in cleantech that’s capturing CO2 from the environment, you’re going have to have a building in which to house your machines and, obviously, you’re going to have the machines and all of the parts that go into them. These are all capital expenditures.
Capital Expenditures on the Balance Sheet
Now, capital expenditures are interesting in the accounting world because they get treated slightly differently from regular operating expenses. Operating expenses are things such as:
- Employee salaries
- Food/Catering
- Hotels
- Travel
If capital expenditures are over $2500, they are actually “capitalized” on the balance sheet. This means they are put in an asset count on your balance sheet and you recognize the expense. You amortize or depreciate those fixed assets over time. The length of time you depreciate those fixed assets depends on what they are and what the IRS’s guidance is.
Usually that’s about two to five years. It’s the kind of thing that gets washed out on your tax return and, often, there’s some adjusted journal entries at the end of the year to make sure that the amortization/depreciation schedules match your tax returns.
So when you make capital expenditures they will be reflected on your balance sheet as an asset, and that asset’s going to be reduced every year by the annual depreciation and amortization that’s applicable to that asset.
CAPEX on the Cash Flow Statement
As well as being on the balance sheet, CAPEX is also reflected on your cash flow statement as it falls under investing activities. The structure of the cash flow statement will generally go as follows:
- The first group to appear on a cash flow statement will be operating activities. These are usually things like your net income.
- Then there will be some add-backs, like working capital.
- Next will be other kinds of balance sheet accounts that may fluctuate to get to your cash flow provided from operating activities.
- Finally you’ll have investing activities, which is what capital expenditures fall under. Again, you’ll see those big cash outflows being reflected there, along with depreciation offsetting it.
Your cash flow statement is a very easy way for investors to see what’s actually happening in your startup’s finances. They look at the cash flow statement quite a bit when they’re looking at capital expenditures.
Debt Financing for CAPEX Heavy Companies
If you are a heavy machinery/heavy asset kind of business, you have to be able to talk to your VCs accordingly. You need them to understand that these are large investments and that companies of this kind are typically going to need a lot more venture capital than, say, a software company or a consumer packaged goods (CPG) company, for example. If your startup requires large machinery and other assets, you will most likely use debt financing to augment your venture capital equity.
VCs who invest in CAPEX-heavy companies are typically very close with a lot of lending firms. They know them and they can make referrals. They have them on their speed dial as it were, and that debt is actually a very important ingredient if you’re running a capital-intensive startup. You will have to finance a lot of that stuff. Debt has a lower cost of capital than equity, and if you use too much equity to finance capital purchases, you’re probably experiencing a little bit more dilution than you need to. Debt helps mitigate some of the dilution.
So when you’re in a board meeting, or you’re pitching your capital intensive business, please remember that you may have to finance yourself in a slightly different way. The financial combination for your startup will be different. You should also know that the accounting treatment is going to be different. A lot of those assets will be capitalized on the balance sheet and they will be reflected on the investing activities portion of the cash flow statement.
Finally, only annual depreciation and amortization will be shown on your income statement as an expense.
Capital Expenditures and Cash Runway
With CAPEX and the cash runway of a company, we tend to look at them in two ways. We look at it on an accrual accounting basis, in which depreciation/amortization is included and the big capital expenditure is not. Then we also look at it as the pure cash flow burn rate, in which the big capital expenditure is included. When the cash leaves the bank account, the cash flow statement is going to be your friend. It adds those investing activities back into the burn rate and shows you what your true burn rate is.
VCs for Capital-Intensive Startups
If you’re running a capital-intensive startup, it’s usually harder to raise money but you will often have less competition. There is a subset of VCs that focus solely on those kinds of companies. So go find them! They will speak your language and they’ll be excited about what you’re doing!
If you have any other questions on capital expenditures, valuations, startup investing, startup accounting, or taxes, please contact us.
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