Framing your expenditure choices as CapEx vs OpEx is, mostly, a bad way to look at it.
Both capital expenditure and operational expenditure are vital statistics in understanding the health of your company on a cost-vs-value (CapEx) and day-to-day expenses (OpEx) level. The real trick is knowing when to pay attention to either, when they’re good to use together, and what you can learn or take warnings from with both.
That’s why we’re here. Today’s post will cover:
- What is CapEx?
- What is OpEx?
- CapEx vs OpEx
- What about COGS?
- What do CapEx, OpEx, and COGS mean for SaaS?
- How to know when you should take on a migration from CapEx
Let’s get started.
What is CapEx?
Let’s say that you want to expand your operations, so you buy new chairs, desks, computers and so on to facilitate more team members. You could immediately resell these things for a good price, or after 5 years of use for a much lower price due to wear and tear. Until they’re completely trashed, they have a potential resale value.
This makes them assets that add their potential value to your company’s total value.
CapEx or “capital expenditure” refers to business expenses in acquiring such assets that will be beneficial beyond the current tax year. These assets must have some kind of value and be something that you could theoretically sell in order for their cost to fall under CapEx.
It’s worth taking a closer look at the “beneficial beyond the current tax year” element, as this is perhaps the biggest factor in determining what falls under CapEx other than the purchase being an asset.
CapEx acquisitions can have an immediate effect on your profit and loss statement (P&L). However, to qualify as CapEx they need to affect your P&L over time. This is despite carrying (usually) a large immediate cash price or even a downpayment far in advance of seeing any benefits.
The speed at which your assets depreciate in value also dictates how much of the total purchase cost you can record as an expense. With CapEx you take the asset’s usable lifetime (over which the asset will be reducing in value), and split the purchase cost to record an equal portion of it during each financial period over said lifetime.
Since we’re almost there already, let’s cover the basics of CapEx when it comes to accounting.
First, CapEx assets aren’t deductible, so no writing the cost off in your tax bill. Second, ASC 842 now means that loaned items are also considered CapEx instead of just purchased items, so be careful of that.
The final accounting-based point to consider with CapEx is applicable if you have to follow FASB accounting standards. In other words, this only matters if you’re a public company, you get audited, and you’re considering being acquired or you’re receiving institutional investment. If this is you, your accountant should have no trouble defining what should be capitalized (classed as capital expenditure) and what should not - the GAAP, and thus FASB, guidelines are very straightforward.
What is OpEx?
OpEx or “operational expenditure” refers to the expenses brought about to run your business for a single day. This can’t be anything that will add value to the business (eg, acquiring new assets) - OpEx is solely concerned with costs to keep your business running.
Since OpEx can’t include anything which adds value to the business, nothing that has a resale value can be included. However, since these costs are necessary for the day-to-day running of your business, OpEx is generally deductible.
As such, costs that fall under OpEx include wages and salaries, travel costs, property taxes, rent and utilities, accounting fees, legal fees, and so on.
Speaking of accounting, it’s worth noting an important element of subscription service fees when it comes to OpEx.
Plenty of subscription services offer discounts for committing to periods of longer than a month. However, when you do this you can’t log the entire amount on the invoice in the month that you take out the contract. Instead (if you follow FASB/GAAP standards) you have to amortize the subscription price to every month that the service applies.
You may have heard of this before - it’s called “accrual accounting”.
For example, let’s say that you sign up for a year of Aimably’s AWS Spend Transparency Software and want to pay for all of it at once. The total cost (minus the setup fee) would be $828, but the OpEx would be $69 per month for a single AWS account.
CapEx vs OpEx
When considering CapEx vs OpEx, CapEx is the cost for acquiring assets that add value to your business, is paid for up-front (usually in advance), and the value of those assets depreciates over time. OpEx is the sum of the costs for the day-to-day running of your business.
However, CapEx vs OpEx is only a valid comparison in certain situations.
CapEx is not a valid replacement for OpEx (and vice versa) when it comes to examining your business’ finances. They compliment each other in producing reports that give a more comprehensive picture, but are not useful if that means ignoring the other.
OpEx as a figure demonstrates at a glance what your daily cost of operations looks like. This makes it ideal for a high-level overview of your costs, especially when the person viewing your finances (eg, the CEO) doesn’t have time to dive into more detailed financial reports.
CapEx is similarly useful in showing at a glance whether any investments are being made to boost the value of the company. When combined with other SaaS finances such as COGS, recurring revenue, active user count, and so on, you can create a rock-solid financial report to tell your founders, CEO, investors, and even stakeholders exactly what financial state your business is in.
CapEx vs OpEx makes more sense as a concept when it comes to investor evaluations and when considering how you can expand your operations.
For investors, CapEx will always be preferable to OpEx. This is because if you compare the same amount spent on CapEx vs OpEx, CapEx adds asset value to your company’s balance sheet while having the same effect on profitability as OpEx. Said assets will depreciate over time, meaning that the CapEx benefits are only temporary, but it’s still value, and higher value is always more attractive to investors.
Finally, when expanding your operations there can be an element of deciding whether to take on CapEx or OpEx. In most cases this will be self-apparent and you won’t have a choice - new employee salaries are OpEx, for example. However, in cases such as expanding to new offices you may have the option to outright buy something (eg an office building) or merely rent it. In these situations it’s worth considering the effect on your bottom line (CapEx adds value whereas OpEx doesn’t) and whether you can afford it, both in terms of the initial cost of CapEx and the fact that only OpEx is tax deductible.
What about COGS?
Put simply, OpEx includes any day-to-day costs of running your business that aren’t directly related to the production of your goods or services, such as rent and utilities. COGS is the inverse - it covers the costs which are directly tied to your goods and services, such as the cost of materials to create the product and logistics costs for shipping it to retailers.
The two are separate figures in your financial reports. You can’t record something as OpEx and under COGS, but something that would be COGS could be reclassified as CapEx or OpEx if it’s an expense for an asset that adds value to your company, or it’s required for the production or delivery of your product or service.
For example, let’s say that you have an AWS account through which you host your SaaS product. Most of your AWS bill goes to COGS because without it you wouldn’t be able to host your product, but if you’re in a data center then only the cost to maintain the center goes towards COGS. The other costs are instead classified as CapEx.
As for investors, they tend to look least favorably on COGS versus CapEx and OpEx. This is because your COGS stand for things that you can’t sell (such as CapEx assets) and can’t reduce or eliminate them from your income statement while delivering similar service to your customers (such as OpEx).
What do CapEx, OpEx, and COGS mean for SaaS?
CapEx, OpEx, and COGS are all important factors to consider in traditional brick-and-mortar businesses. However, the real value of them shows when you’re approaching from a SaaS point of view.
So let’s say you’re a company looking to expand its infrastructure. You’ve reached or are quickly approaching the limit of what your current resources offer, and in order to keep growing, your spending needs to increase with it.
Prior to SaaS and cloud computing in general, you would have had to purchase and deploy the facilities and technology necessary to grow your operations yourself. This would largely class as CapEx, as you’re growing your operations (providing extra value through assets) in order to facilitate general expansion.
However, that’s no longer the case. Now you can take advantage of the tools and facilities that others have already built up on a subscription basis, turning that CapEx into OpEx or even COGS, for a much lower monthly fee.
Obviously you need to bear in mind that converting your potential CapEx into OpEx or COGS won’t be as favorable when it comes to investor assessments. You’re no longer purchasing assets with a resale value, so your financial statements won’t benefit from that.
Even so, the flexibility and speed that OpEx offers can be a massive benefit, especially when it comes to SaaS companies which need to move quickly, expand, and iterate often in order to survive. This is even more true for early-stage startups where money is tight and solid infrastructure and supplementary tools can make or break the team.
Perhaps more importantly is that OpEx as opposed to CapEx means conserving your cash. You don’t have to spend a lot upfront on assets before you even know if the business is going to be viable - you can subscribe to services and/or lease what you need instead.
Conversely, once you reach a certain stage in your business, it can be beneficial to start converting your OpEx back into CapEx. Once you’ve proven your model is successful and your growth is slowing down after your initial success, buying out what you were previously outsourcing is a great way to save money in the long run and add value to your balance sheet. Heck, DropBox saved $75 million in part thanks to doing just that!
How to know when you should take on a migration from CapEx
What if you’ve already taken on the CapEx and you’re working out of a data center? With the boom of the cloud market, as a CTO you’ll get pressure right and left to migrate to a cloud provider like AWS, but there are serious financial implications of doing so.
Knowing when to migrate from CapEx to OpEx can be difficult, as to be sure that you’re making the right move you need to carefully budget and model what your expenses will look like.
For the sake of keeping things simple, for the rest of this section imagine that you’re a company that’s considering moving from a data center (CapEx) to a cloud provider like AWS (OpEx/COGS).
The first thing to consider is how experienced your CFO is with companies that work primarily through OpEx instead of CapEx. The move to AWS could leave them wholly unprepared to deal with the fluctuating COGS and non-contracted spending versus the comparatively stable CapEx.
To mitigate this issue you need to have a solid budget in place for the landscape after the move to AWS and you need to have forecasted accurate predictions so that you know what’s coming.
Don’t worry if you need to brush up on your budgeting skills or have never worked with AWS before - check out our free AWS budget guide, EC2 instance pricing guide, and S3 pricing guide for a full rundown of how to do this!
Ultimately only you can make the decision whether or not migrating is the right choice for you. Remember that CapEx does boost your company’s value and (in the long term) can open the pathway to much greater profits. Just don’t get carried away committing to an existing CapEx system because that’s the way things have always been - the flexibility that OpEx provides can allow your company to iterate, change, and flourish.