Difference Between Capital Expenditure and Revenue Expenditure

What Is Capital Expenditure?

The amounts spent on acquiring, improving, and the upkeep of physical assets like real estate, buildings, plants, equipment, and technology are capital expenditures (CapEx). Businesses frequently utilise CapEx to fund new projects or expenditures.

CapEx refers to the amount of money a company spends on existing and new fixed assets to maintain or expand its operations. Any expenditure that a corporation capitalises or recognises as an investment on its balance sheet rather than an expense on its income statement is referred to as CapEx. 

The method of capitalising on an asset is to spread the expense of investment across the item’s useful life. The quantity of capital that a company is required to spend is determined by the industry in which it operates. The most capital-intensive businesses with the biggest capital expenditures include exploration and gas, telecommunications, manufacturing, and utilities.

CapEx may be reported as cash flow from investment activities in a company’s cash flow statement. Different organisations define CapEx differently, and an analyst or investor may see it represented as capital investment, property purchases, plant and equipment (PP&E), or acquisition expenditure. Capital expenditures can also be calculated using a corporation’s income statement and balance-sheet information. Determine the current period’s depreciation expenditure as reflected on the income statement. Find the current period’s property, plant, and equipment (PP&E) line-item balance on the balance sheet.

Find the prior period’s PP&E balance and subtract it from the current period’s PP&E balance to determine the change in the company’s PP&E balance. To calculate the company’s current-period CapEx, add the difference in PP&E to the current-period depreciation expense.

Operating expenses are not the same as capital expenditures (OpEx). Running expenses are short-term expenses required to meet a company’s continuous operational requirements.

Operating expenses, unlike capital expenditures, can be deducted from a company’s taxes in the year they occur. A cost is considered CapEx if it is a freshly bought capital asset or an investment with a life of more than one year or if it extends the usable life of an existing capital asset.

On the other hand, if the expense keeps the asset in its present condition, such as a repair, the cost is usually deducted in full in the year the item is acquired.

Types of Capital Expenditure

Capital expenditures may include purchasing the following items:

  • A building or factory, including any expansions or modifications
  • Vehicles used for commodities transportation, such as trucks, and manufacturing machines computers
  • Furniture

Businesses commonly use capital expenditures to support new initiatives or investments. CapEx is frequently used to boost a company’s revenue and profit.

On the other hand, revenue expenditures comprise operational costs for running the day-to-day business and maintenance fees to keep the asset in good working order.

Businesses frequently utilise debt or equity financing to meet the significant expenditures associated with acquiring critical assets for their growth. Borrowing money from a bank or issuing corporate bonds, IOUs issued to investors in return for periodic interest payments, are examples of debt financing. The practice of issuing shares of stock or equity to investors to acquire funding for expansion and capital investments is known as equity financing.

What Is Revenue Expenditure?

Revenue expenditure, often known as OPEX, accounts for expenses incurred throughout its operations. It is defined as the entire amount of money enterprises spend on manufacturing processes. Usually, such expenses do not result in asset development, and the advantages of OPEX are confined to a single fiscal year. They are generally not in charge of developing or expanding their earning potential. Regardless, they are crucial in optimising the management of operational activities and assets and generating revenue within a specific accounting period.

Rent, salary, wages, commission, freight fees, and other revenue expenses are only a few examples. Notably, factors such as the type of commercial enterprise, the purpose of a venture, the frequency of operations may be used to classify expenditures as OPEX.

In accounting, revenue expenditure for an accounting period is reflected in a corporation’s Income Statement. However, the company’s balance sheet does not reflect this.

Furthermore, they may be tax deductible in a particular accounting period because such expenses are recurrent. It is also worth noting that OPEX is not capitalised and that no depreciation is applied to such expenditures.

Revenue expenditures or operating expenses are reported on the income statement. These expenses are subtracted from the revenue earned by a company’s sales to determine the net income or profit for the period. Revenue costs may be tax-deductible in the year in which they occur. In other words, the expenses reduce the profit from a tax standpoint, decreasing taxable income for the tax period.

Types of Revenue Expenditure

Revenue spending falls into two categories:

  • Direct expenditures are expenses incurred mostly during manufacturing. The following are the most typical direct expenses: direct pay, freight charges, import duty, commission, rent, legal fees, and power costs.
  • Spending incurred due to the sale and distribution of completed goods or services is indirect expenditure. Examples are salary, repairs, interest, commission, depreciation, rent, and taxes. These costs may also include money spent on handling routine administrative expenses.

Here are a few more instances of revenue expenditures:

  1. Wages and pay for employees
  2. Any item that comes within the category of selling, general, and administrative expenditures, such as corporate office salaries (SG&A)
  3. Development and research (R&D)
  4. Utilities as well as rent
  5. Property taxes for business trips

Capital and Revenue Expenditure Examples

Consider the following examples to show how capital and revenue costs are recorded in the books of accounts:

Example of Capital Expenditure

Examples of capital expenditures are as follows:

  • Buildings (including subsequent costs that extend the useful life of a building)
  • Computer equipment
  • Office equipment
  • Furniture and fixtures (including the cost of furniture that is aggregated and treated as a single unit, such as a group of desks)
  • Intangible assets (such as a purchased taxi license or a patent)
  • Land (including the cost of upgrading the land, such as the cost of an irrigation system or a parking lot)
  • Machinery (including the costs required to bring the equipment to its intended location and for its intended use)
  • Software

Otherwise, a cost is reported if any of the following two conditions applies:

  • The spending is less than the business’s stated capitalisation limit. The capitalisation restriction is in place to prevent businesses from spending time monitoring low-value equipment, such as computer keyboards.
  • The expenditure is for an item consumed entirely within the current reporting period.

Example of Revenue Expenditure

A&J invests 100,000 BDT in manufacturing equipment. A monthly cost of 1,000 BDT is charged to maintain the machine’s operation. In this scenario, the revenue expenditure is 1000 BDT, utilised to pay the machine maintenance cost every month. When the revenue statement is created, a line item for the month the maintenance fee will be included in the 1000 BDT. If the machine develops a fault and requires repair, the repair cost will be included in revenue expenditure and reported in the month in which the expense occurred.

Difference between Capital expenditure and Revenue Expenditure

Parameters Capital Expenditure Revenue Expenditure
Definition The money spent by a company to acquire new assets or improve the quality of existing ones is referred to as capital expenditure. Revenue expenditure refers to the money spent by businesses to run their day-to-day activities.
Time-span Long-term capital investments are made. Revenue costs are often incurred over a shorter period and are confined to a fiscal year.
Treatment in accounting books CAPEX is documented in a company’s balance sheet. It is also included as a fixed asset on a company’s Balance Sheet. OPEX is frequently reported in an organisation’s P&L but not in its Balance Sheet.
Purpose A corporation will incur such costs to increase its earning capability. A corporation must bear such expenses for it to stay profitable.
Yield, The return on these investments is frequently long-term and not restricted to a single year. The return on these costs is effectively restricted to the current fiscal year.
Capitalisation of expenses Capital outlays are capitalised. Revenue expenditures are not capitalised.
Examples Buying machinery or obtaining a patent, gaining copyright, installing equipment and fittings, and so on. Wages and salaries, power costs, printing and stationery, inventory, postage, insurance, taxes, and maintenance fees are just a few examples.

What Is the Face Value of a Share?

The Indian stock market is growing at such turbo-speed that, according to a Bloomberg article, India’s listed market capital is just 4% behind the UK’s!

With the increasing enthusiasm of Gen-Z towards the market, India’s stock market participation is projected to keep expanding in the long term. But before you venture into the fascinating stock market world, it is crucial to start with the basics. And today, we deep dive into the meaning of face value and explain how it differs from market value.

So what exactly is the face value of a share?

Investors buy shares of companies at market price, but many are unaware that each share has a designated face value. Let us look at this fundamental feature of a share.

When a company is formed, it has to issue equity shares to its promoters and register the incorporation papers with the Registrar of Companies (RoC). The face value of the shares issued to promoters is mentioned in the Memorandum of Association (MoA), Articles of Association (AoA) and other documents submitted to the RoC and other Government Authorities. Hence, the face value of a share holds pivotal significance for a corporation.

Similarly, when a company goes public, i.e., makes a fresh issue of securities in the public market, it has to determine its shares’ face value. This face value is mentioned in the documents submitted to authorities at Initial Public Offering. Therefore, the issuing company’s responsibility is to keep the SEBI, Stock Exchanges, Clearing Houses, and the public informed of its shares’ par value.

About share/ bond certificate and some noteworthy takeaways

When a company goes public, it issues securities or bonds with a particular value. In the earlier decades, physical share and bond certificates were issued to the security holders. These physical certificates mentioned the face value for the holders’ reference. The mandatory requirement of physical certificate issuance is done away with, and the transfer happens through brokers’ online sites or apps.

Face value helps determine the accounting value of the shares and bonds issued, which is mentioned in the company’s financial statements – particularly the balance sheet.

For your detailed understanding, here are some crucial points to keep in mind:

  • The issuing company determines the face value of its shares.
  • The face value of stocks and bonds is duly noted in the company’s balance sheet. 
  • A Share’s face value is the initial cost of the share and duly assigned to it.

What is the essence of the face value of a share?

For an investor, it is crucial to be aware of the face value of the asset that they are purchasing. This knowledge comes in handy when stock splits happen due to corporate actions. So if a company decides to split its share with a face value of Rs. 10 into ten shares of the face value of Re. 1 each, the investor would notice a tenfold jump in the quantity of the inventory held. But that does not equate to a ten times monetary benefit as the market value of the share also gets aligned with the new face value.

Another point to note is that when a company declares dividends, it is based on the financial value of the share, irrespective of its market value. 

Face value knowledge helps in understanding the following –

  1. The market value of a share is correlated to its face value.
  2. Company issues dividends for its shares based on their face value.
  3. In the case of bonds, face value is the basis for calculating interest rates.

The fundamental difference between face value and market value

Market value is the rate at which the company’s shares are exchanged between the buyer and seller – determined by market conditions. Market value is not the same as the book value.

To understand the fundamental difference between the face value and market value of a share, let us look at the table below –

Particulars Face Value Market Value
Price The face value price remains constant until changed explicitly by the company itself. The market value price keeps changing as per market conditions. 
Determined by The issuing company fixes face value at its discretion. The market dynamics determine market value. It constantly changes as the trading on exchanges continues.
Calculation The total number of shares issued by the company multiplied by its face value determines its share capital. A company’s market capitalisation is calculated by multiplying the stock’s current market value with the number of outstanding shares.

Can the face value of shares be modified?

Once determined by the issuing company, the face value of a share mostly remains the same. In specific cases, the company may decide to change the face value. Such decisions need various compliance actions on the company’s behalf. The company would need to pass a shareholder’s resolution and alter the Capital Clause of the Memorandum of Association. Also, various submissions are to be made with the Registrar of Companies and Stock Exchanges.

Generally, face value changes when the company splits stocks. In such cases, the face value of the share is reduced as per the company’s directives. In some instances, the face value is also increased by the company.

Debt-to-Equity (DE) Ratio

Open up a company’s balance sheet, and you will see two separate columns or categories – Assets and Liabilities. While the assets represent the company’s owned resources that have the potential of generating income, liabilities represent what the company owes. 

Furthermore, the balance sheet contains a section on shareholder’s equity which shows the amount attributable to the company’s shareholders. When investing in a company, a study of the balance sheet can give you an insight into how the company is performing. You can also use various ratios to find the company’s potential. One such ratio is the debt to equity ratio. Let’s understand it. 

What Is Debt-to-Equity Ratio?

Debt is an external source of finance for a company, while equity is an internal source of finance. The company uses both these sources of finance to fund its operations and growth. However, when estimating the financial standing of a company, its debt and equity are viewed independently and in conjunction with one another. An analysis of debt v/s equity gives you an idea of how leveraged a company is and whether your investments would bear fruit or not. 

To this extent, investors use various gearing ratios to measure the company’s equity against its liabilities. The debt-to-equity ratio is one such ratio that can help investors understand how leveraged the company is. Let’s explore this ratio further. 

The debt-to-equity (D/E) ratio is a metric that helps you assess the proportion of debt and assets used by a company to finance its operations. 

How is the debt to equity ratio calculated?

The ratio is calculated using the following debt to equity ratio formula

Debt to equity ratio = Total liabilities / shareholders’ equity

In the formula, the numerator and denominator are defined as follows –

  • Total liabilities = short-term liabilities + long term liabilities + outstanding debt payments
  • Shareholders’ equity = equity share capital + reserves and surplus 

For instance, the balance sheet of HDFC Bank Limited for the financial year ending on 31st March 2021 is as follows (Source: https://www.moneycontrol.com/financials/hdfcbank/balance-sheetVI/HDF01) –

Particulars  Amount (Rs. in crores rounded off)
Equity share capital 551
Reserves and surplus  203,170
Deposits (liability) 1,335,060
Borrowings 135,487
Other liabilities and provisions 72,602

From this balance sheet, the calculations would be as follows –

Total liabilities  Deposits + borrowings + other liabilities and provisions 

= (1,335,060 + 135,487 + 72,602) crores

= Rs.1,543,149 crores

Shareholders’ equity Equity share capital + reserves and surplus

= Rs. (551 + 203,170) crores

= Rs.203,721 crores

Debt to equity ratio Total liabilities / shareholders’ equity 

= Rs.1,543,149 crores / Rs.203,721 crores

= 7.57

What does the ratio mean? 

The ratio of debt to equity gives investors considerable insights into a company and its financial standing. Here’s what the ratio says about a company’s finances: 

  • If the debt to equity ratio is high, i.e. above 2 or 2.5, the company is considered risky from the investment point of view. A high ratio indicates that the company has higher debts than equity. If the debts become too much, the company might fail to repay them and file for bankruptcy. 

If the company files for bankruptcy and liquidation, its assets would be first used for paying off the debts and then the shareholders. If the debts are high, there might be nothing left for the shareholders to claim. If you have invested in such a company, you will lose your capital.

A high ratio is, thus, considered risky. If you are a risk-averse individual, investing in companies with a high ratio of debt to equity might prove counterproductive. You should, thus, look for companies that have a low ratio, i.e. below 2 or 2.5.

  • A high debt to equity ratio can also be interpreted as being good. It shows that the company has availed of debt for expansion and growth. Since the cost of raising debt is lower than the cost of raising equity capital, the company might stand to benefit. Higher debt for growth might lead to enhanced revenue and, consequently, enhanced profits. If the profits exceed the cost of servicing the debt (i.e. the interest payable on the debt), the shareholders stand to benefit. Enhanced profits mean a possibility of enhanced dividend payouts. Moreover, when the company is profitable, its market perception increases. This also boosts the stock price. If you have invested in the company, an increasing cost price means better profits and capital appreciation. 
  • A high debt to equity ratio can also provide a higher return on equity (ROE) as the company can use debt to generate better returns for shareholders.
  • The Weighted Average Cost of Capital (WACC) can also be reduced with increased borrowing because of the cost factor. Debt capital is cost-effective compared to equity capital. A high debt to equity ratio, thus, is good for lowering the WACC of the company. 

A high debt to equity ratio can, thus, show both a negative and a positive picture. You should, thus, assess the ratio with other metrics too to analyse if the company is a worthy investment or not. 

Interpretation of the debt to equity ratio:

While the debt to equity ratio can help you assess the investment risk and the company’s growth potential, its interpretation is open to debate. It has certain drawbacks that you should keep in mind when understanding the ratio. 

For instance, companies in different industries can have different debt to equity ratios. This is because their sources of capital vary. For comparison purposes, the debt to equity ratio is industry-specific.

Take the instance of HDFC Bank, which was illustrated earlier. The bank’s debt to equity ratio is 7.57, which is very high compared to the accepted standard average of 2 or 2.5. Does this mean that HDFC Bank is a risky investment?

Not exactly. Take the instance of Axis Bank, another company in the same industry. Its balance sheet reads as follows:

Particulars  Amount (Rs. in crores rounded off)
Equity share capital 613
Reserves and surplus  100,990
Deposits (liability) 707,306
Borrowings 142,873
Other liabilities and provisions 44,336

Now if we calculate its debt to equity ratio, it would be done as follows –

Total liabilities  Deposits + borrowings + other liabilities and provisions 

= (707,306 + 142,873 + 44,336) crores

= Rs.894,515 crores

Shareholders’ equity Equity share capital + reserves and surplus

= Rs. (613 + 100,990) crores

= Rs.101,603 crores

Debt to equity ratio Total liabilities / shareholders’ equity 

= Rs.894,515 crores / Rs.101,603 crores

= 8.80

Axis Bank too has a high debt to equity ratio signifying that the banking sector might experience a high debt to equity ratio. A high ratio is common for the industry and does not necessarily depict higher risk.  

If you compare Axis Bank (debt to equity ratio of 8.80) and HDFC Bank (debt to equity ratio of 7.57), it would be a fair and relevant comparison. Both banks have a high debt to equity ratio compared to the standard value. However, Axis Bank tends to be slightly riskier than HDFC Bank based on its debt to equity ratio

Another limitation is the inclusion of liabilities when calculating the ratio. Some analysts use short-term and long-term liabilities and other provisions in calculating the ratio, while others use only short and long-term liabilities. Similarly, some analysts exclude non-interest-bearing debts while others don’t. There is even ambiguity in terms of including preferred share capital in liabilities. Some experts believe that preferred stock should be included in liabilities, while others have an opposing view. 

Reading the balance sheet and segregating the liabilities can also pose a problem when calculating the debt to equity ratio. Some items might look ambiguous, and getting the right value for liabilities can be challenging. 

So, be careful when interpreting the ratio to avoid any ambiguity. 

The bottom line

Investing your hard-earned money in a company requires a little research. You should analyse different financial ratios that depict the financial standing and stability of the company as well as its profitability. The debt to equity ratio is one such ratio that is an important parameter in assessing the leveraging opportunities that the company is using. 

Leverage shows how the company uses its assets and liabilities to generate profits and can also determine the share price movements. Assessing the leverage is, thus, important and the debt to equity ratio helps you do just that. So, understand what the ratio means and how to calculate it.

Also, use the debt to equity ratio in conjunction with other important ratios when considering investing in a company. 

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