Purchases of fixed assets and purchases made to upgrade fixed assets are the two different types of capital expenditures (capex). Fixed assets are physical property with a useful life that extends far beyond the current year. The property also has to be of a certain nature to qualify as a fixed asset rather than a current asset. Physical property treated as a fixed asset has to have a quality of permanency, such as real estate or major machinery, rather than something that may have a useful life of many years but that is easily moved or sold, such as a computer printer. The fixed assets category is commonly referred to on a budget as property, plant, and equipment (PP&E).
Business expenses must be correctly categorized for accounting and tax purposes. Assets that a company acquires during a fiscal year can either be treated as current or fixed, which affects how the asset is treated for tax purposes. An asset is considered current if it used up in the current or subsequent year or can easily be converted to cash. The expense to acquire a current asset is written off on the company's books in the year the asset is acquired.
A fixed asset is property that has a long useful life and cannot be easily sold or converted into cash. This type of property cannot be expensed in the year it is acquired. The tax code requires the cost of fixed assets to be amortized over its useful life, meaning the entire cost has to be spread out over the years the property will be used and an equal portion is deducted every year. Property depreciates each year, which is another expense the company has to record in its accounting system.
Capital expenditures are monies spent on PP&E. There are two types of cash outlays that will qualify the expense as capital for tax purposes. If a company buys anything that is considered a fixed asset, the expense is a capital expenditure. Expenses to upgrade a fixed asset or extend its useful life are also considered capital. Any outlay of money to acquire a current asset is instead considered an operational expenditure (opex).
The importance of classifying capital expenditures is primarily related to tax treatment, but it has other implications for a company's financial operations as well. Businesses operate according to a yearly budget, and operational budgets manage cash flow over the course of a fiscal year. Fixed assets are carried separately on a capital budget that only reflects capital expenditures. Buying or developing PP&E typically requires large outlays of cash, complex financing, and an acquisition plan that spans multiple years, which requires management to identify assets upfront so they can be properly accounted for in the company's financial plan.
