Lingo Explained : Capex vs Opex

When dealing with the financial management of a business, the accountancy terms “Capex” and “Opex” will frequently turn up… Yet what do they mean? Let’s start off with the basic definitions ;

Capex

Capital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing asset with a useful life that extends beyond the tax year.

Opex

OpEx (Operational expenditure) refers to expenses incurred in the course of ordinary business, such as sales, general and administrative expenses (and excluding cost of goods sold – or COGS, taxes, depreciation and interest).

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Still a bit fuzzy? How are they treated from an accounting perspective ;

Capex

Cannot be fully deducted in the period when they were incurred. Tangible assets are depreciated and intangible assets are amortized over time.

Opex

Operating expenses are fully deducted in the accounting period during which they were incurred

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Still a bit fuzzy? Let’s do some examples… ;

Capex

  • Buying a laser printer
  • Buying machinery and other equipment, acquiring intellectual property assets like patents

Opex

  • Buying paper and tones for a laser printer
  • Wages, maintenance and repair of machinery, utilities, rent, SG&A expenses

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So which one is preferred?

From an income tax perspectives, businesses typically prefer OpEx to CapEx. For example, rather than buy laptops and computers outright for $800 apiece, a business may prefer to lease it from a vendor for $300 apiece for 3 years. This is because buying equipment is a capital expense. So even though the company pays $800 upfront for the equipment, it can only deduct about $250 as an expense in that year.

On the other hand, the entire amount of $300 paid to the vendor for leasing is operating expense because it was incurred as part of the day-to-day business operations. The company can, therefore, rightfully deduct the cash it spent that year.

The advantage of being able to deduct expenses is that it reduces income tax, which is levied on net income. Another advantage is the time value of money i.e. if your cost of capital is 5% then saving $100 in taxes this year is better than saving $104 in taxes next year.

However, tax may not be the only consideration. If a public company wants to boost its earnings and book value, it may opt to make a capital expense and only deduct a small portion of it as an expense. This will result in a higher value of assets on its balance sheet as well as a higher net income that it can report to investors.

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Yet be wary… Where a CFO might be sensitive towards Capex, the common pitfall is to ignore the TCO of a given investment. Some investments will have a low Capex profile, yet their Opex cost will drive the TCO upwards, where it might have been better to go for the investment with a higher Capex profile…

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So what do you have to keep in mind? Your CFO will be sensitive to,Capex, yet be wary to achieve to most optimal TCO.

Major source for the above ; http://www.diffen.com/difference/Capex_vs_Opex

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Lingo Explained : ROI, NPV, IRR

When talking about projects, you often see the following terms popping up ; ROI, NPV & IRR. Yet what do they mean?

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ROI

  • Abbreviation : Return On Investment
  • In Short : The ROI will give you an indication how fast you will have a return on your investment. It’s mostly expressed in a period of years, when calculating with costs related to a year.
  • Wikipedia : http://en.wikipedia.org/wiki/Return_on_investment
  • Formula :

    return on investment = (gain from investment – cost of investment) / cost of investment

  • Video : Youtube

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NPV

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IRR

  • Abbreviation : Internal Rate of Return
  • In Short : The IRR will indicate the “interest” you get from an investement. It’s often used as a metric to see if money shouldn’t be kept with the finance institution instead of within a (risky) investment.
  • Wikipedia : http://en.wikipedia.org/wiki/Internal_rate_of_return
  • Formula :

    Check here…

  • Video : Youtube

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And how does that related to decision making?

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Lingo Explained : From Baseline to Target

The definitions according to Togaf ;
Baseline : “A specification that has been formally reviewed and agreed upon, that thereafter serves as the basis for further development or change and that can be changed only through formal change control procedures or a type of procedure such as configuration management.”
Target Architecture : “The description of a future state of the architecture being developed for an organization. There may be several future states developed as a roadmap to show the evolution of the architecture to a target state.”
Gap : “A statement of difference between two states. Used in the context of gap analysis, where the difference between the Baseline and Target Architecture is identified.”
Transition Architecture : “A formal description of one state of the architecture at an architecturally significant point in time. One or more Transition Architectures may be used to describe the progression in time from the Baseline to the Target Architecture.”

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So to translate this to the terms that are already being used in “the real world” too;
Baseline : The baseline is the “AS IS” situation. This is something you should already be aware of, as this is your operational baseline for your configuration management, and thus the basis for all change requests (as probably generated from an architecture change).
Target : This is the “TO BE” situation, your “flag in the distance” to indicate where you want to be.
Transition Architecture : These are your waypoints to get to your goal (being the target). Sometimes these are called “Interim Targets”, where they are called “Plateau” according to the “Implementation & Migration” extension of Archimate.
Gap : The “diff” between your starting point (“AS IS”) and your destination (“TO BE”).